February 26, 2012

Repatriation of Offshore Corporate Profits

Yesterday Mitt Romney made a statement about the repatriation of corporate profits that got me hopping mad.  It angered me, in part, because Romney certainly understands the issue better than most people, but obfuscated the truth in order to score political points with an unknowing public.  He said that as president he would encourage the return of a trillion dollars currently held by foreign subsidiaries of US corporations so the funds could be invested in jobs here, rather than in outside markets.  Presumably he would do this by reducing, or eliminating, the income tax on repatriated dollars.  According to him, these dollars arise when a US corporation establishes an offshore presence—his example was an auto plant in China—from which it generates profits.  These profits, he said, will be invested in foreign markets if not brought back to the US.

This analysis is disingenuous on so many levels.  The first is related to how the profits are derived.  Romney is right when he says they’re generated by the foreign operations of US corporations, but what he failed to say is that in most cases the profits arise through something called transfer pricing associated with interactions with shell companies.  Transfer pricing is an important aspect of the tax and treasury operations of many global businesses.  In fact, it’s so important that people who understand its ins-and-outs are paid as if they were professional athletes.

The way transfer pricing works is by first establishing a shell company in a tax haven—the Cayman Islands, for example.  The shell company is then caused to purchase important licenses or other rights that are central to the corporation’s operation.  High tech companies are especially fond of selling software licenses to their offshore entities.  Since the shell companies have no assets, they must raise cash to purchase the licenses, but this is generally accomplished through intercompany loans.  These transactions—the selling of licenses and the borrowings—are, of course, transactions only on paper. 

Here is what a corporation is then able to do.  Every time a product is sold, it owes its foreign shell company a licensing fee, which appears as an expense on the corporation’s income statement and thereby reduces its taxable income.  In other words, this is essentially a means to avoid the payment of tax.  The shell company, on the other hand, is located in a tax haven, and though it receives revenue, it incurs no tax liability.  It can use a portion of the fees it receives to make interest and principal payments on the intercompany loan.  Over time, however, the shell company records substantial excess cash balances that in a real sense represents the parent company's deferred tax obligation. 

If the corporation wishes to repatriate the balances, it can do so through a dividend payment, but that would be a taxable event.  However, teams of tax accountants and lawyers work to come up with other ingenious ways to move cash around, including intercompany lending from the shell company to the parent.  I mention this for several reasons.  First, the repatriation of corporate cash is an issue that arises primarily because global companies have found creative ways to AVOID their tax obligations.  Second, allowing the repatriation to occur in a tax-advantaged manner, as Romney suggests, only gives corporations more reason to continue with the practice.  Third, corporations can find creative ways to return cash to their home operations, but they won't do so until domestic demand increases and requires expansion.  The tax-free repatriation of cash is another example of how conservatives are only interested in supporting corporate and other well-heeled interests and should be flatly rejected.  

Finally, Romney and other conservatives say repatriated dollars will be invested in such a way that it will result in job creation here.  If that's the case, why haven't corporations used the over $2 trillion contained in domestic corporate bank accounts to grow manufacturing?  US corporations are generating tremendous profits due to efficiencies gained through massive layoffs.  They're sitting on those profits and will continue to do so until Americans begin to consume again.  The key to overcoming our economic malaise is not to allow corporations to withhold contributions into the community pot that benefits us all, but to put more cash in the pockets of the middleclass.  It's time corporations pay their fair share. 

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