BETTER TAX TREATMENT WOULD HELP FREE TRAPPED CASH / THE FINANCIAL TIMES INSIDE FINANCE ( HIGHLY RECOMMENDED READING )

Better tax treatment would help free trapped cash

By Francesco Guerrera

Published: October 18 2010 22:30

In their 1936 play You Can’t Take It With You, George S. Kaufman and Moss Hart contrasted the eccentric-but-happy Vanderhof family with the rich-but-uptight Kirbys.


The resulting comedy poked fun at the American dream and, as the title suggests, its brazen pursuit of money.


Turns out the Pulitzer-prize winning duo were wrong. If you are a US company, you can definitely take it with you, provided that you move it abroad.


In its quest to capture US corporate profits around the globe, the Leviathan also known as the US tax system has spawned a monster of a loophole. Unlike his peers in other countries, the US taxman believes US companies’ overseas profits should be subject to domestic taxes, typically in the 25-35 per cent range.


The charges, however, are deferred until companies bring the funds back home. This creates an incentive for corporations to park the cash abroad, depriving the domestic economy of resources.


In recent times, the problem has been exacerbated by the breakneck pace of cash generation among US companies. Since 2008, S&P 500 companies, excluding financials, have added some $130bn of cash to their coffers, bringing their total gross cash to a record $1,000bn.


Shareholders, politicians and bankers want chief executives to spend the money on investments, dividends and deals. And yet corporate America seems strangely unable to loosen the purse strings.


Part of this reluctance stems from the fact that the money is not in the US. Internal estimates by JPMorgan suggest that up to 40 per cent of the $1,000bn pile is “trapped” overseas for tax reasons.


Cash-cow companies such as Cisco, Microsoft and General Electric – and their friends among investment bankers and Republican politicians – have seized on the US economic sluggishness to press for a tax holiday on foreign profits.


They argue that bringing cash back would unleash investment and jolt the domestic economy out of its slump without adding to the nation’s deficit.


Tax holiday-lovers point to the $300bn-plus repatriated by US companies in 2004 and 2005 when the levy on foreign profits was temporarily lowered to 5.25 per cent.


But that was George W. Bush’s doing. Barack Obama and his Treasury secretary Tim Geithner have zero interest in giving big business a (tax) break.


The administration thinks of another repatriation holiday as paying ransom to kidnappers. Officials argue that it would weaken the US government’s credibility on taxation whilst rewarding companies for keeping cash out of the country.


The Obama camp also contests the idea that such a move would be cost-free. Under government accounting rules, any foregone tax has to be reflected on the balance sheet of US Inc.


Part of that lost tax would be offset if companies were indeed to use the repatriated money to invest in economic activities. But, and here lies a major weakness of the pro-holiday argument, that is not a certainty. Much of the cash imported in the 2004 amnesty went to investors through dividends and share buy-backs, rather than on capital expenditure and research and development.


What’s even more questionable is why $400bn or so in extra cash would prompt companies to open the spending faucets.


If $600bn already at hand domestically, an extremely favourable debt market and ultra-low interest rates haven’t done it so far, the issue is clearly not money but fear of the uncertain economic outlook.


Being Italian, I am naturally attracted to any new holiday, especially one involving taxes, but it is not at all clear a freebie on foreign profits would spur US growth.


Taxing US companies on their overseas profits is, in any case, unusual and should really be abolished. But that’s unlikely to happen given the dire state of Uncle Sam’s finances.


A more viable way to ensure that money flows back and is put to good use would be encourage companies to spend at least part of their cash pile on capital expenditure and R&D.


Here the tax code could really come in handy. Instead of a blanket break on all returning cash, the government could offer better tax treatment for funds that are spent on productive activities in the US.


The administration has already proposed allowing companies to write off new investments in plants and equipment in one year, rather than up to two decades.


Linking such a plan to the release of “trapped cash” could stimulate the economy without amounting to a king’s ransom for the tax-minimising denizens of corporate America.


Francesco Guerrera is the FT’s US Finance and Business Editor

Copyright The Financial Times Limited 2010.