The Repatriation Dilemma: Cash May Be King, But Is Earnings Per Share Trump?
By David L. Bernard
TaxBlawg’s Guest Commentator, David L. Bernard, is the recently retired Vice President of Taxes for Kimberly-Clark Corporation, a past president of the Tax Executives Institute, and a periodic contributor to TaxBlawg.
The financial press can’t stop talking about the amount of cash on corporate balance sheets. Journalists and arm-chair analysts alike point to the $1.84 trillion in cash on the balance sheets of non-financial U.S. companies as a reason to be bullish on the stock market, figuring that eventually cash-rich companies will splurge on dividends and stock buy-backs, if not on pursuing growth opportunities. There’s probably truth to that, but there is also a good chance that some of the cash will never be spent. Why? Because much of this largesse has been earned outside the United States in low tax jurisdictions, and repatriating this would cost billions in cash taxes and earnings.
The Chief Tax Officer (“CTO”), CFO and Corporate Treasurer have many discussions on the desire to return cash to the U.S. and the amount of the resulting “hit” to income that would result. Some companies may have more of a tolerance for the reduction in earnings per share attendant with repatriation of low taxed earnings than others, but the growth in cash in corporate balance sheets suggests that earnings per share still trumps the desire to return cash to the U.S. when the tax burden is too great.
Let’s take a look at the latest 10K filings for four of household names: General Electric (GE), Microsoft (MSFT), Intel (INTC) and Apple (AAPL). (GE’s effective tax rate references exclude the impact of GE Capital)
|$Billions Unless Otherwise Noted|
|Cash and cash equivalents||$ 72.3||$ 36.4||$ 13.8||$ 34.0|
|Permanently invested foreign earnings||$ 84.0||$ 29.5||$ 10.1||$ 5.1|
|Pre-tax foreign earnings to total||54%||62%||80%+||55%|
|Effective tax rate (“ETR”)||19.4%||25.0%||23.4%||29.0%|
|Impact of foreign earnings on ETR||(10.7%)||(12.1%)||(12.4%)||(8.2%)|
The financial statements of these giant U.S. based multinationals have several things in common. They all report tens of billions in cash and cash equivalents, billions in permanently invested earnings outside the U.S., and effective tax rates far below the statutory rates in the U.S. In each case the company’s tax footnote cites foreign earnings taxed at low rates as the primary driver of the effective tax rate.
Indeed, low-taxed foreign earnings are clearly a substantial earnings per share driver in each company. If you “do the math,” on a weighted average basis the foreign to U.S. tax-rate arbitrage benefit is over 11% of the total net income of these four companies. Moreover, the fact that there is little or no U.S. deferred tax provided on the foreign earnings means these companies are not planning to repatriate the foreign cash balances and trigger the loss of cash and the earnings per share “hit” that would result.
If you believe this is not that common, think again. International tax planning and tax rate differences have benefited the bottom lines of most U.S. based multinationals and left them with a repatriation dilemma. A review of financial statements bears this out. Witness P&G’s $30 billion in permanently invested foreign earnings and 7.5% rate arbitrage benefit, Merck’s $1.2 billion arbitrage benefit and Caterpiller’s $9 billion in unremitted earnings. What’s more, the impact of international tax planning and statutory rate differences appears to be growing in most of the companies analyzed. For example, as cited above AAPL’s effective tax rate in their fiscal year ended September 26, 2009, was 29%. But so far over the first 9 months of its 2010 fiscal year, AAPL has reported a 25.8% effective rate. This reduction in tax rate accompanies a 57% rise in pre-tax income. Guess what that tells you…. much of the earnings growth is coming from low-taxed operations outside the U.S.
So what does this tell us about the conversations that are occurring among the senior financial officers within U.S. based multinationals? What is their thinking about the use of this foreign cash? Are they consulting with the CTO? How (or should) recent legislative developments and future legislative prospects affect their decisions?
The CTO has to proactively communicate the potential costs associated with the repatriation of stockpiles of low taxed foreign cash. CTOs not “out in front” on this issue are liable to fall victim to an uninformed decision, and it may be too late to stop the train. Conversations with the CFO and CEO may begin with one or the other discussing the pressure being placed on the company by investors to use their cash in ways that improve target metrics such as earnings per share growth and returns on invested capital. The conversation may then turn to how they can access the large cash balances held outside the U.S. The CTO has to be able to tell them what the cash and earnings impacts would be associated with the repatriation of various pockets of cash. In other words, the Tax Department better be keeping these earnings and profits calculations up to date.
While the CEO and CFO bemoan how the the current record low yields on cash investments make targeted metrics more difficult to achieve, the CTO has to remind them that international tax planning and statutory rate differences has resulted in accelerating growth in low tax earnings, which have become a major contributor to growth in earnings per share. Repatriating those earnings would effectively eliminate that portion of the earnings growth, and analysts would be likely to discount future earnings estimates.
The conversations may end with a decision to retain the low taxed earnings offshore and wait for an attractive alternative use for the cash. Such alternatives may include international acquisitions, capital investments, or funding more research and development outside the U.S. Some companies may also be waiting for the political landscape to change, facilitating a short term legislative fix to this problem such as the Section 965 85% foreign dividends received deduction temporarily available about 5 years ago under the 2004 American Jobs Creation Act. The reality of course is that the present administration and congress is “headed in the opposite direction”, looking to increase the U.S. tax collected on foreign earnings. Look no further than the recent foreign tax credit “splitter” and section 956 changes, and the failure to pass the Sec. 954(c)(6) look-through subpart F exception.
While managements search for uses of foreign cash and the political and legislative landscapes play out, companies will continue to be scrutinized over their cash hoards, and the conversations in the board rooms and executive suites will continue. But don’t expect the final decisions to be different from those previous. Ultimately, although cash may be king, earnings per share is the trump card.Explore posts in the same categories: Corporate, International comment below, or link to this permanent URL from your own site.