Investors love to point to the massive stockpiles of cash sitting on U.S. corporate balance sheets as evidence that dividends will rise dramatically.
There's only one problem with this cheery view: A huge amount of that money is sitting offshore, and it's not clear when – or how – it will find its way home.
Consider Apple Inc. , now the world's largest company by market capitalization. In its first-quarter report, the company disclosed that it was sitting on $97.6-billion (U.S.) in cash and marketable securities – a staggering figure that stoked speculation the iPhone and iPad maker will soon initiate a dividend. Apple's CFO Peter Oppenheimer was vague, saying only that the company "is actively discussing the cash balance."
Yet $64-billion of Apple's cash – roughly two-thirds – is held by foreign subsidiaries subject to sharply lower tax rates than in the United States. If Apple were to repatriate some of that cash for dividends or share buybacks, it would face U.S. corporate tax of 35 per cent, less a credit for any foreign tax paid.
Apple is far from alone. As of Dec. 31, more than half of Google 's cash and marketable securities of $44.6-billion was held by foreign subsidiaries. At Microsoft , about 89 per cent of its $51.7-billion cash hoard sits outside the United States.
All told, U.S. companies have an estimated $1.5-trillion to $1.8-trillion parked offshore, Martin Sullivan, a former U.S. Treasury Department economist and contributing editor at Tax Analysts, said in an interview. These funds are effectively "locked out" because of the stiff U.S. taxes repatriation would attract, he said.
In other words, don't count on that money coming home any time soon.
While that may come as a disappointment to investors, nobody should shed a tear for these companies. The lockout problem is largely of their own making, Mr. Sullivan said, because they hire armies of lawyers and accountants to creatively shift profits to tax havens, when most of the value – things such as technology patents and product design – was created in the United States.
To be sure, some profits are legitimately earned in the country where they are reported, but there are countless tricks companies use to move money to where it attracts the least tax.
To take a simplified example, a U.S. company would sell or license the foreign rights to its intellectual property to a subsidiary in a tax haven such as Bermuda or the Cayman Islands. The subsidiary would then collect royalties and book profits on foreign sales of the company's products, effectively shifting income from a high-tax jurisdiction to a low-tax one. The parent company should charge fair-market prices when transferring rights to subsidiaries, but because of the gaping difference in tax rates – and the porous nature of "transfer pricing" rules – it has a strong incentive to charge as little as possible.
Such abuses of the system aren't illegal, but they cost the U.S. Treasury tens of billions of dollars annually at a time of spiralling government deficits. This has turned the problem of offshore profits into a political issue, with companies such as Apple, Google, Microsoft and Pfizer lining up behind the "WinAmerica" campaign that's lobbying Washington for repatriation at a reduced tax rate of about 5 per cent.
WinAmerica argues that a tax break on repatriated profits would spur U.S. investment, create new jobs and "provide an immediate jolt to our economy." But critics point to the last tax holiday in 2004, when some companies used the repatriated cash for share buybacks and – far from investing in their domestic operations – slashed their U.S. payrolls.
Handing companies another tax holiday would only make the lockout problem worse, Mr. Sullivan said. "If they were to do it again there would be no job creation in the short run, and in the long run it would give the multinationals more incentive to use the offshore loopholes," he said.
President Barack Obama, who is opposed to a tax holiday, has proposed a minimum tax on foreign profits that would apply to all U.S. multinationals. He also supports a reduction of the 35-per-cent U.S. corporate tax rate, which most people agree is too high.
"Right now, companies get tax breaks for moving jobs and profits overseas. Meanwhile, companies that choose to stay in America get hit with one of the highest tax rates in the world. It makes no sense, and everyone knows it. So let's change it," Mr. Obama said in his recent State of the Union address.
With an election later this year, it will likely be 2013 at the earliest before Congress passes a tax-reform bill. And nobody knows what the final legislation will look like, or if it will open the door for all that foreign cash to come home.
All of which suggests that dividend investors shouldn't start rubbing their hands just yet.
John Heinzl