Made in the U.S.A., but Banked Overseas

“U.S. multinational firms have established themselves as world leaders in global tax avoidance strategies,” says Prof. Edward Kleinbard.

Imagine how frustrating it would be to have billions of dollars in cash but be unable to spend it as you wish unless you paid a large part to the Internal Revenue Service.

That could be your problem if you were running a large multinational corporation based in the United States.

Profitable companies that operate only in this country have some tax breaks available and so often pay considerably less than the statutory corporate tax rate of 35 percent. But they still face a significant tax bill.

It is a different story for United States companies that operate internationally.

“U.S. multinational firms have established themselves as world leaders in global tax avoidance strategies,” said Edward D. Kleinbard, a former chief of staff of Congress’s Joint Committee on Taxation who now teaches tax law at the Gould School of Law at the University of Southern California.

In a recent article, he sarcastically added that those companies “are burdened by tax rates that are the envy of their international peers.”

The companies avoid United States taxes largely by claiming that much of their income is earned in countries where taxes are low — or even nonexistent. Apple books profits from patents developed in the United States in an Irish subsidiary that is not taxed there or anywhere else. Caterpillar earns money by producing tractor parts in the United States and selling them to Canadian farmers. It books the profits in a Swiss subsidiary.

Companies are supposed to pay United States taxes at a 35 percent rate — minus any foreign taxes already paid — when the profits are brought back to this country. And that is where the frustration comes in.

In practice, the rules on bringing cash home are not exactly ironclad. Companies can put the money in banks. They can use the cash to buy bonds, or even stock, in other American companies. They can reinvest it in foreign operations or buy a foreign company.

But they can’t legally use it to take over another American company or to pay dividends.

As the multinationals have become better at avoiding American taxes — and it is much easier for a company with intellectual property like patents or copyrights than it is for companies that simply make and sell things — those untaxed profits have climbed into the billions.

In 2004, intense corporate lobbying persuaded Congress to pass what was called the American Jobs Creation Act. A section of that bill, called the Homeland Investment Act, said that, for one time only, companies could bring the money home and pay only a 5.25 percent tax rate. Companies promised they would use the cash to invest in research and development, build plants and hire Americans. There were safeguards that were supposed to keep the money from being used to pay dividends.

The safeguards did not work. On average, one study reported, companies that brought back money used 60 percent or more of the cash to increase dividends or buy back stock. What they did not do was use the money to hire people or invest in the United States.

But a precedent was established. Companies concluded that it was foolish to bring money home and pay the normal tax rate. Lobbying had produced a tax break once, and perhaps it could do so again.

A lobbying campaign for a similar break failed last year.

“Congress did not enjoy the sensation of being misled and abused,” Mr. Kleinbard said.

As the cash built up on balance sheets, earning low returns under current interest rates, shareholders looked at it enviously. They wanted to gain access to it without the company having to pay taxes.

Credit...Jonathan Ernst/Reuters

One way to do that is called an inversion, in which an American company buys a foreign one but structures the deal so that the headquarters of the new company is overseas in a country with a lower tax rate.

The company may still be owned by the same investors and run by the same managers working in the United States. But there are ways to transfer the money to the “new” parent without paying taxes.

Inversions have been around for years, and in fact were restricted by that 2004 tax act, which required that the foreign company being acquired be at least a quarter as large as the American one. That limitation meant United States companies had to at least merge with a real company rather than set up a foreign shell company, as some had been doing.

This week, the Obama administration announced new regulations to toughen the way that computation is made and to make it harder for an inverted company to gain tax-free access to its overseas cash. It said it was also working on regulations to limit what is called “domestic earnings stripping,” a way to move taxable profits from the United States company to a foreign affiliate.

The regulations will most likely have some effect, but it would take legislation to really reduce the abuse. A senior Treasury Department official said he hoped Congress might act in the lame-duck session after the November election, but don’t hold your breath.

As it is, the system is absurd. A company can exploit the fiction that its overseas subsidiary is a different company and sign contracts to move profits wherever it wishes.

A company that has done that, and has built up overseas profits, has a tax incentive to build a new plant overseas rather than in the United States.

A company that really needs the money built up in purported overseas profits may have to pay taxes to get at it. But if the company is rich enough, its credit will be good enough to allow it to borrow money to pay shareholders, and thus face no tax. That is what Apple did. Call it the Reverse Robin Hood effect.

One way to deal with the absurdities would be to simply drop the idea that the United States taxes profits globally. But if companies could continue to claim that profits really made in this country were made abroad, that would be equivalent to simply abolishing taxes for American multinationals. To make sense, any such move would require the closing of many loopholes that allow companies to move income around.

A simpler solution would be to impose a tax on the consolidated profits of a multinational company — as companies report consolidated earnings to shareholders — and then allow the company to take a credit for taxes actually paid to foreign countries.

The statutory tax rate would have to come down substantially from the current 35 percent, but it could then have some relation to what was actually paid. Mr. Kleinbard advocates such a move in his book “We Are Better Than This: How Government Should Spend Our Money,” which is to be published next week by Oxford University Press.

What happens, and whether anything happens, may depend on whether the administration is successful in persuading people that the government must raise enough money to pay for needed services and that allowing wealthy multinationals to largely avoid taxation simply shifts the tax burden to others.

Unfortunately, that competes with another attitude that has gained popularity in recent years — that taxes are by definition bad and anyone who manages to avoid paying them legally is to be congratulated and emulated.

When the Senate Permanent Subcommittee on Investigations held a hearing in April that exposed the tactics Caterpillar had used to avoid United States taxes, the condemnation from some Republican senators was directed not at the company but at the panel’s chairman, Senator Carl Levin, Democrat from Michigan.

Senator Rand Paul, Republican of Kentucky, offered apologies to Caterpillar and to its auditor, PricewaterhouseCoopers, which had advised the company on its tax strategy. Senator Rob Portman, Republican of Ohio, seemed to think that any company not following the Caterpillar example would be acting wrongly. “It is a fiduciary responsibility if you are a public company,” he said, “to look where you can maximize profits.”

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