Piles of Overseas Profits Investors Can See but Not Touch
It has become a $2 trillion question. Why don’t companies have to make clear exactly how much of their profits are generated offshore each year and not taxed in this country? Why must investors engage in jujitsu to estimate these figures and the risks associated with them?
Companies, like individuals, do everything they can to minimize their tax bills. And as long as it is legal to do so, companies that book profits in overseas jurisdictions with beneficial tax treatments are perfectly within their rights to keep those earnings out of Uncle Sam’s clutches as long as they can.
The problem is, accounting rules don’t require a company to record a deferred income tax liability on these profits, as long as it says it intends to reinvest earnings in the foreign jurisdiction where they were generated. So the money piles up, contributing mightily to reported corporate profits.
Untaxed foreign earnings disclosed by companies in the Standard & Poor’s 500-stock index last year climbed to more than $2.1 trillion, according to Jack Ciesielski, president of R.G. Associates and editor of The Analyst’s Accounting Observer.
Last year, Mr. Ciesielski said, 322 of these companies generated $182.4 billion offshore, an estimated 19 percent of their total net income.
Companies provide few details on their reinvestment intentions, making it seem as if they are reaping the benefits of the rule without really following it. And the piles have grown so large — about $90 billion at Microsoft, for example — that claims of plans to reinvest this money overseas simply aren’t credible.
“If they don’t have concrete plans for the money, which they haven’t really shown us that they have, the deferred tax liability should be right there on the balance sheet — full stop,” said Lee Sheppard, a contributing editor to Tax Notes, the definitive publication on national and global tax issues. “But companies don’t want to book the deferred tax liabilities because that would affect their share prices.”
Requiring companies to book these deferred tax liabilities does not appear to be imminent. This issue is not on accounting rule makers’ agendas.
But with untaxed foreign earnings into the trillions, Mr. Ciesielski said investors might not fully understand how much they contribute to a company’s profits. While some companies, like Microsoft, make fairly clear disclosures, others do not.
“These companies know what they are saving in taxes by moving things around,” Mr. Ciesielski said in a recent interview. “They could disclose more.”
There are risks associated with these offshore earnings. One is that a company may bring the money home with taxes owed, as General Electric recently decided to do. Another is that foreign jurisdictions may increase their tax rates, bringing them closer to parity with the United States and reducing the benefit of keeping the money offshore.
A third risk, Mr. Ciesielski said, is posed by the rising dollar. Among companies whose overseas operations generate profits in foreign currencies, keeping them offshore to avoid American taxes is essentially making a currency bet. If the foreign currency falls against the dollar, so too will the value of the offshore earnings held in that jurisdiction.
“Why not just have all companies say, ‘Here’s what the earnings number would have been had we recognized the taxes’?” Mr. Ciesielski said. “That would tell investors how much possible tax risk there is in the earnings.”
To get a handle on the share of companies’ earnings that are made up by foreign profits, Mr. Ciesielski analyzed the financial statements of 347 companies that provide some information about foreign untaxed earnings.
He estimated that these companies’ net income would have been reduced by 8.5 percent in 2014 if they had paid taxes in the United States on the offshore profits. In 2013, he estimated that net income at 344 companies would have been lowered by 7.2 percent. (In both calculations he compared the companies’ foreign effective tax rates as shown in their financial statements with the statutory rate in the United States of 35 percent.)
Many companies, of course, pay far less than the 35 percent rate on their earnings in the United States, and they employ plenty of high-priced lawyers and accountants who would help them figure out how to minimize payments on foreign profits. And it’s no secret that business groups are lobbying Congress to provide an escape hatch that would allow them to bring home foreign profits at a deeply discounted tax rate.
Still, the exercise is highly useful, for it indicates how much overseas profits are contributing to overall earnings among these companies and what might happen if the beneficial tax treatment changed.
Here’s another reason for more detailed disclosures: Earnings kept overseas, unlike those generated at home, cannot be distributed to shareholders in the form of dividends. Lumping foreign earnings together with those that are generated domestically implies an availability and liquidity about them that does not exist.
“If these companies are not going to bring the money back, how can you say that’s income available for shareholders?” Mr. Ciesielski asked.
Today’s accounting treatment of offshore earnings is very reminiscent of the 1990s, when companies were allowed to hand out truckloads of stock options to executives and employees without deducting them as a business expense.
Until rule makers decided in 2005 that stock options did have a cost associated with them and that it had to be run through the income statement, companies simply noted options’ costs in the fine print of their financial statements. This effectively inflated the earnings of companies that heavily relied on options for employee compensation.
Many of them were technology companies. And today, the tech sector is one of the biggest beneficiaries of offshore earnings tax treatment.
The battle to expense stock options took almost a decade to win, so don’t expect accounting rules on foreign untaxed earnings to change anytime soon. But that doesn’t weaken the case for booking deferred taxes on overseas money.
“Accounting rules presume that when you have a foreign subsidiary and it’s earning money, you will pay the money to the parent in the U.S. as a dividend and you will pay appropriate taxes on it,” Ms. Sheppard said. “The real question is why companies don’t book a deferred tax liability for this.”