Friday, February 22, 2013

the repatriation tax

If an American company earns profit in another country, it has to pay that country's income taxes. But if it then chooses to bring that cash back to America, it owes U.S. taxes, minus a credit for foreign taxes already paid.

So imagine Cisco earns $1 billion profit in Switzerland. It will owe Switzerland's 8.5% corporate tax. But if Cisco then brings the remaining $915 million back to the U.S. to pay dividends or expand its workforce, it will owe another 26.5% to the IRS -- the difference between Switzerland's 8.5% tax rate and America's 35% rate. It's called the repatriation tax.

Cisco's other option is to keep the money in Switzerland (or whatever country it earns overseas profit in). Not surprisingly, that's what most global corporations choose to do. As of last March, U.S. companies held about $1.2 trillion in total cash. But almost 60% of that was sitting in foreign bank accounts, according to Moody's.

Some companies hold the vast majority of their loot abroad. About 80% of Oracle's (NASDAQ: ORCL) cash is held overseas. Apple (NASDAQ: AAPL) holds close to 70% of its cash outside the U.S.

There are two crazy things about the repatriation tax. The first is that it doesn't raise much money for the U.S. Treasury. Using the most bearish assumptions, The Joint Tax Committee estimates that ending the repatriation tax altogether would raise deficits by about $8 billion per year -- a rounding error measured against $2.9 trillion in total revenue. A separate estimate from the Congressional Budget Office shows that ending repatriation taxes would actually raise federal tax revenue, since companies would likely bring more cash home to pay dividends, which are then taxed. Either way, repatriation taxes have a trivial impact on the federal budget.

Second, the repatriation tax is virtually unique to America. Of the G-7 group of nations, only America exercises a repatriation tax. Among the 34 OECD nations, 26 impose a "territorial" tax system, where profits are only taxed where they are earned, with no repatriation owed when earnings are brought back to a company's home country. Two of the last holdouts, Japan and the United Kingdom, switched to a territorial tax system in 2009.

With the competition based in countries that use territorial tax systems, American companies are at a disadvantage.  The easiest way for them to compete is to keep foreign profits in foreign bank accounts. The loser is the U.S. economy.

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