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Some Analysts Say Foreign Corporate Cash Repatriation May Have Little Impact On US Capital Investment

By Jacqueline Baratta

Jacqueline Baratta is an undergraduate student majoring in Accounting in the Eli Broad School of Business at Michigan State University.

U.S. companies like Microsoft (SYMBOL: MSFT) and General Electric(Symbol: GE) are holding billions of dollars of profits overseas in foreign subsidiaries also know as CFC. A CFC, or a Controlled Foreign Corporation, is any corporation organized outside the U.S. that is more than 50% owned by the U.S. shareholders. They are doing so to defer paying US corporate income taxes until they repatriate these foreign earnings.

The United States government taxes income on corporations operating domestically and internationally. This is not a new problem. According to a 2007 paper in the Journal of Financial Economics

"To reduce double taxation, the Internal Revenue Service (NYSE:IRS) grants foreign tax credits for income taxes paid abroad by CFCs and generally defers taxes on foreign income until it is repatriated if the affiliates are separately incorporated in foreign countries" (Foley et al, 2007).

Foreign earnings unlike domestic earning of US companies are taxed when they are repatriated to the U.S. company in the form of dividends.

A lower tax rate in a foreign country provides an incentive not to repatriate the foreign earnings and pay the high United States taxes. Therefore, corporations retain a greater share of their earnings in these low tax territories for extended periods.

In addition, this tax implication provides the additional incentives for corporation to decide to invest those funds in overseas production facilities, headquarters location and transfer pricing to the United States to limit domestic profitability.

Today, according to Deloitte's report on corporate income tax rates for 2017, the United States has one of the highest national corporate income tax rate among developed countries at 35%. Worldwide corporate income is taxed when it is returned to their home countries.

Data Source: Deloitte (Corporate Tax Rates 2017, Updated March 2017)

Current Tax Legislation Proposal

President Trump is working with Congress to reduce corporate tax rates to 15% and to limit deductions. In addition, he proposes to allow firms to repatriate foreign profits held overseas at a favorable 10% tax rate.

House Republicans would prefer a 20% top rate, with "border adjustability", meaning that companies would get to keep profits on exports tax-free. President Trump's lower tax rate would encourage companies to repatriate some of their income held abroad and redeploy in the United States.

According to the global strategy note from the Pavilion Financial Corporation, a global investment services firm, as published on Business Insider, "Tax breaks to encourage firms to repatriate their foreign cash holdings have tended to overwhelmingly benefit shareholders, largely through share buybacks," the note said. "Conversely, these deals have had little impact on long-term investment or employment. Going forward, we question the efficacy of another tax break and think take-up could in fact be low."

The cash problem has happened before. In 2004, the American Jobs Creation Act passed, triggering a large repatriation of foreign cash holdings. The AJCA had a provision under section 965 that According to the Pavilion U.S. companies repatriated $312 billion, 45% of foreign cash holdings. At the time, the $312 billion was taxed at a rate of 5.25%.

Pavilion found that there was no appreciable increase in investment in the domestic economy as a result. The number of employees before the recession was higher compared to when the American Jobs Creation Act was passed. Dividend payments to shareholders and hiked share buybacks to boost stock prices occurred.

The proposed tax reduction and reduced repatriation proposal is just one part of an economic plan that must be implemented to create a more attractive environment to incentivize companies to invest in plant and equipment in this country.

If this favorable investment environment is created in conjunction with the proposed tax changes then companies will invest domestically because their return on their domestic investment will provide a greater return than a foreign investment.

It is shown that when the US corporate tax rate is competitive with rates levied by major G20 nations the incentive to keep foreign profits overseas is vastly reduced or eliminated. If the federal government incentivizes corporations to repatriate profits with a favorable tax rate history has shown that they will repatriate the profits.

However, if our additional objective to have them reinvest in the domestic market then additional policy changes must be incorporated that provides companies an incentive to invest domestically those foreign profits. Corporations make investment decisions on prospective or anticipated returns and by making the domestic investment landscape attractive they should invest those additional repatriated profits.