A new study finds that U.S.-based multinational corporations move an average of $12 billion in taxable income back into the country each year without paying taxes, thanks to complex mergers and acquisitions.
The study, by Emanuel Zur, an assistant professor of accounting and information assurance at the University of Maryland's Robert H. Smith School of Business, and two coauthors, Xiumin Martin of Washington University and MaryJane Rabier of McGill University in Canada, comes amid a renewed debate over the repatriation of corporate profits stashed abroad. Senators Rand Paul, R-Ken., and Barbara Boxer, D-Calif., announced this week a proposal to provide tax incentives to encourage U.S. companies to repatriate their foreign profits and use the tax revenue to fund highway improvements (see Corporate Tax Holiday to Fund Highways Gets Boost in Senate).
Prior academic studies have examined how companies keep cash abroad, to avoid those taxes. It has been estimated that U.S. companies are holding some $2 trillion in cash, most of it overseas.
“But this is the first time anyone has provided large-scale empirical evidence and put a number on the amount of money entering the U.S.,” Zur said in a statement. “This is money that should be taxed.”
In the study, Zur and his coauthors looked at the behavior of 625 companies and 2,795 foreign or domestic acquisitions from 1990 to 2004, when $184 billion returned to the United States without being taxed. (2004 was the year of a government-sanctioned tax holiday on repatriated income, spurring many companies to repatriate their offshore profits, although few of the jobs anticipated by the tax holiday materialized. If anything, tax-free repatriation has increased since then, however, according to the researchers.)
The paper confirms earlier research showing that companies that earn money in low-tax nations are likelier than their peer companies to invest that money abroad, in order to keep the funds there. Stock markets generally react negatively to those investments, indicating that such business moves don't make much business sense.
The study describes how companies facing high repatriation taxes also acquire U.S. companies, through extraordinarily complex maneuvers, with nicknames such as "Killer B," "Deadly D," and "Outbound F." In a "Killer B" deal, a profitable foreign subsidiary of a U.S.-based company declines to issue a dividend to the parent company (a taxable event). Instead, the parent company acquires a domestic subsidiary.
The foreign entity then purchases stocks from the parent company with cash, and transfers that stock to the U.S. subsidiary, in exchange for the stock of the U.S. subsidiary. The result of this head-spinning process: A tax-free return of profits to the U.S.
Although not illegal, this is an “inappropriately aggressive” practice, Zur suggests.
“Congress intended that that money should be taxed,” he said. “That is the spirit of the law, and that was the intention of lawmakers.”
However, major companies such as IBM, Johnson & Johnson and Eli Lilly have engaged in these types of acquisitions.
Once transactions such as these attract negative publicity, the IRS typically issues rules banning them, and the Obama administration has been aggressive on this front. “But these companies have so many lawyers working for them that they are always going to be a step ahead,” Zur said.
The researchers do not offer solutions to the problems they have identified. (President Obama and Congressional Republicans have said that lowering the corporate-tax rate and closing loopholes is a goal they agree on, in principle.) The study provides data about activities encouraged by current corporate-tax laws that are both economically inefficient and cost the U.S. billions.
