A strategy for investing offshore cash that beats inversion

One of the stories that firms deserting our country like to tell is that by moving their corporate domicile (but not their actual headquarters) outside U.S. borders to duck taxes, they will be able to use cash they have parked offshore to expand their operations in the United States.

So when the rules the Treasury issued in September upended the biggest proposed corporate “inversion” in history—Illinois-based AbbVie’s $54 billion takeover of Ireland-based Shire — there was whining about how the Treasury is killing prospective American jobs.

To which I say: Give me a break. Under current law, it’s already relatively simple, inexpensive and profitable for an American company to use its offshore cash for productive and job-adding U.S. projects. And as I think you’ll see, the method we’re talking about, which Standard & Poor’s has dubbed “synthetic cash repatriation,” looks like a better long-term deal for shareholders than paying a multibillion-dollar premium to buy an offshore company with which to do an inversion deal.

In an inversion, a U.S. company buys a foreign company, technically sells out to it, and thus transforms itself into a non-U.S. company to avoid high U.S. taxes. But it continues to benefit from being in our country. That why I (and subsequently President Obama) have taken to calling these inverters “deserters.”

As of June 30, S&P estimates that the U.S. companies whose credit it rates held $906 billion of cash offshore, money that would be subject to the 35 percent U.S. corporate tax if companies brought it home directly.

But there’s a simple and obvious way for companies to use the cash indirectly to fund U.S. investments. Think of it as “clever borrowing.”

Here’s how it would work. It’s a play in three acts.

Act I: We start with something I learned from tax expert Edward Kleinbard, a University of Southern California law professor and a prolific, witty and effective polemicist whose new book, “We Are Better Than This: How Government Should Spend Our Money,” is a must-read for anyone who wants to be educated about taxes and social policy.

Kleinbard told me something that I should have known but didn’t: that U.S. companies are required to pay U.S. income tax on interest and dividends earned on their offshore cash, regardless of whether that income is repatriated to this country. (For details, ask a tax techie about Subpart F.) That’s something that very few people know, but it’s really important for our analysis.

Act II: Last April, S&P issued a nifty report showing how some big U.S. companies are indirectly using offshore cash to facilitate cheap borrowings in the United States. That’s the practice that S&P dubs, quite cleverly, “synthetic cash repatriation.” (In case you’re interested — and you should be — offshore cash is 60 percent of the total cash that S&P-rated companies had on their books as of June 30, up from 44 percent at year-end 2009.)

Now, let’s combine Acts One and Two. Because the income earned on offshore cash is taxable in the United States, there’s no penalty for repatriating that income into our country. So a company with offshore cash can borrow in the United States and use the income earned on its offshore money to pay some or all of the (tax-deductible) interest that it incurs on its U.S. borrowing.

If the interest rates at which a company invests its surplus cash offshore and borrows in the United States for projects here were identical, the offshore interest income would totally offset the U.S. interest expense. But in the real world, the money a company would borrow to fund a productive, job-creating project would typically have a longer maturity than the short-term securities in which firms generally stash their offshore cash. Therefore, the U.S. borrowing to fund a project here would carry a higher interest rate than the offshore cash earns.

So let’s say a company is earning 1 percent on its offshore cash and pays 3 percent to borrow here. After taxes — remember, interest paid in the U.S. is deductible to the borrower — that 2 percent spread costs the company only 1.3 percent.

Act III: A big company that wants to make a capital investment in the United States typically has a “hurdle rate” — a minimum return that it expects to earn on that investment — of at least 10 percent after taxes.

If an investment isn’t likely to earn at least the hurdle rate of return, the company probably won’t make it, regardless of where the cash to pay for it comes from. If the projected profit exceeds the hurdle rate, the company will make the investment. Shelling out 1.3 percent after tax to finance an investment expected to earn double digits after tax is a no-brainer.

Using offshore cash to borrow cheaply in the United States strikes me as a better long-term deal for shareholders than having a company spend big money to buy an inversion partner abroad, then having to make that corporate marriage work. (The acquisition has to be sizable, relative to the inverter’s stock market value, for the deal to qualify for inversion treatment under the tax code.)

There’s no question that a 1.3 percent annual cost makes “financial engineering” maneuvers such as using U.S. borrowings to pay dividends and buy back shares less lucrative for shareholders than they would otherwise be. However, as we’ve seen, if a company wants to use synthetically repatriated cash to expand and grow, that 1.3 percent isn’t a big deal.

Conclusion: The idea that a U.S. company with offshore cash has to invert and desert our country to make an investment here is nonsense. Up with intelligent borrowing. Down with whining.

Sloan is Fortune magazine’s senior editor at large.