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ABSTRACT:

This paper examines the cash and earnings holding overseas by the U.S. corporations. Based on the sample of larger S&P 500 companies, the study finds that U.S. corporations with foreign subsidiaries are piling tons of cash and earnings overseas. Further analysis indicates that holding of foreign cash depends on the corporation’s foreign earnings and their U.S. tax liabilities. Finally, analyzing data for the 30 largest S&P 500 corporations by industry, my study collected some evidence that Technology and Pharmaceutical sector corporations are the two dominated sectors in holding foreign cash and earnings overseas. Overall, these findings proved that if another repatriation tax holiday will get enacted, U.S. corporations would bring their money back in the U.S. that they are stocking after the last repatriation tax holiday in 2004.

Keywords: American Jobs Creation Act, repatriation, tax, foreign cash, undistributed foreign earnings, cash and cash equivalents, borrowings, deferred tax liabilities.

Data Availability: All data are available from public sources.

1. INTRODUCTION

In the recent presidential U.S. election, President Donald Trump concentrated massively on the U.S. multinational corporations and corporate tax reform. In the past decade, many U.S. corporations have moved their businesses to foreign countries. The question raised is that why are corporations relocating their businesses outside the U.S.? We all know that the main reason behind the relocation and business inversions is better growth in underdeveloped foreign countries as well as moving to the countries with lower taxes. Corporations have been saving tons of money by reducing their tax liabilities; moving businesses overseas at lower cost of manufacturing costs, at lower tax haven countries, and reinvestment opportunities and foreign acquisitions. In this global business world, corporations find comfortable ways to move their money across countries.

Under the current U.S. tax system, U.S. corporations are generally taxed on their worldwide income which includes their domestic as well as foreign incomes. However, U.S. corporations are 100% exempt from paying taxes on their foreign earned incomes until they bring the money back into the U.S. i.e. repatriation. U.S. corporations are allowed to defer their U.S. tax liabilities with the purpose of re-investment in foreign countries. If corporations repatriate their money, the U.S. allows them to take credit of their foreign paid taxes against their U.S. tax liabilities. I found in prior study, Foley et al. (2007), that if corporations do not have foreign investment plan, companies retain profits in form of cash. The study showed that the repatriation behaviour and withholdings of the company is depended on corporations tax liability.

In this paper, I also analyze how much tax liabilities are deferred by the 30 largest corporations and which industry is holding higher cash and earnings overseas? I compared the 2004 repatriation tax holiday results by industry with the potential holding of these corporations. During my analysis I discovered that at the end of 2015, nearly 60% of foreign earnings and nearly 90% of foreign cash are being held by Technology and Pharmaceutical sector companies. Based on these results, I expand my analysis to see how much debt these two sectors are holding in compare to their foreign cash. My results came out that most of the corporations under these two sectors are holding more cash than debt which indicates that if they have to repatriate their cash back to the U.S. they can payout their liabilities if they want.

Upon further study of the prior research, it has witnessed that corporations are raising more borrowing in the U.S. rather than repatriating their foreign cash. The Wall Street Journal recently mentioned in their 2017 article that Apple Inc. (Apple) borrowed $88 billion to payout dividends to their shareholders. During my analysis it has been noted that Apple has the largest number of cash accumulated overseas and if they repatriate these cash to payout to shareholders it would create significant tax liabilities. I further discovered in Richard and Craig (2014) that rather than repatriating their foreign cash, corporations are using their cash as collateral to borrow money for reduced interest rates.

2. BACKGROUND INFORMATION

A. Taxation of Foreign Earnings:

Currently the U.S. tax system taxes corporations on their worldwide income, including domestic as well as income earned in foreign Jurisdictions. U.S. corporations are taxed at the rate of 35% which is the world’s highest corporate tax rate. To mitigate double taxation, the U.S. allows to take credit of foreign taxes that have been paid in the foreign countries. However, these credits are limited to the amount of U.S. tax liability on the foreign incomes. U.S. corporations would not pay taxes on the income earned from the foreign subsidiaries until those incomes are distributed or brought back to the home country where they have corporate headquarter. Thus, U.S. corporations are deferring their tax liabilities showing their investment plans in the foreign countries which creates incentives for corporations to save on taxes.

Under the U.S. GAAP principles, earnings of foreign subsidiaries are included in the consolidated financial statements of the U.S. parent corporations in the year they were earned. Most of the U.S. parent corporations have succeeded to demonstrate their reinvestment plan in foreign countries and also showed the availability of sufficient source of cash flow from other sources in the U.S. Hence, the undistributed earnings from foreign subsidiaries will be postponed indefinitely and are not repatriated into the U.S.

B. The American Job Creation Act of 2004:

The very first Repatriation Tax Holiday was presented by former president George W. Bush in 2004, also known as the American Jobs Creation Act of 2004. The act allowed U.S. corporations to bring their foreign earnings back to the U.S. at the reduced rate of 5.25% than the statutory corporate rate of 35%. The 2004 tax holiday was optional for corporations and available for one taxable year. The purpose behind this act was to create more jobs in the U.S. by bringing these money back to the U.S. for the domestic investment.

The 2004 tax holiday was enacted with list of permitted and restricted use of the repatriated money. Permitted use of money included: (i) the funding of workers hiring, training, and other compensation, (ii) infrastructure and capital investment in the U.S., (iii) research and development in the U.S., (iv) financial stabilization of the corporation for retention and creation of the job (including repayment of domestic or foreign debt, qualified pension plan funding, and other expenditures), (v) acquisition of certain business entities, (vi) advertisement and marketing in the U.S., and (vii) purchase of intangible property in U.S.. The IRS specifically issued restrictions on the use of repatriated money for: (i) executive compensation, (ii) intercompany transactions, (iii) stock dividends and other distributions, (iv) stock redemptions, (v) portfolio investments in the businesses, (vi) debt instruments, and (vii) tax payments.

The IRS reported that the 2004 tax holiday was successful in bringing $362 billion of profits, of which $312 billion was purely tax revenue. Despite the listed restrictions, I discovered from the prior studies that the 2004 tax holiday was not successful enough to meet their main purpose of improving the economy and creating jobs. Prior research such as Blouin and Kull (2009) and Dharmapala, Foley, and Forbes (2011) have shown that most of the corporations used their repatriated money to repurchase of their own shares or for repayment of debts or for dividend payouts. Dharmapala et al. (2011) showed in their study that $0.60-$0.92 per repatriated dollar was spent in shareholder payouts in 2005. Instead of revenue it raised more costs by losing jobs due to mergers and acquisitions. Prior study stated that Hewlett-Packard brought back profits of $14.5 billions making 14,500 workers jobless and repurchased more than $4 billion for the first half of 2005; Pfizer brought back profits of $37 billion, closed U.S. factories in 2005 and made 10,000 workers jobless; Ford Motor Company brought back profits of $850 million making more than 30,000 workers jobless in 2005-2006; Merck & Co. brought back profits of $15.9 billion making 7,000 workers jobless in 2005; Honeywell International brought $2.7 billion profits back but made 2,000 workers jobless in 2005-2006.

C. The Trump Plan:

During the recent elections President Donald Trump has announced one-time mandatory tax on corporations overseas profits at the reduced rate of 10%. Under the current U.S. tax system, corporations are taxed at the statutory rate of 35% for domestic as well as any foreign earnings upon repatriation less credit applied for any tax paid to the foreign governments. Because of this many U.S. multinational corporations are holding their foreign earnings in foreign countries to avoid paying taxes in the U.S. and continued deferring taxes. To end this deferral of taxes, President Trump has proposed a mandatory repatriation tax on the corporations foreign earnings which can be payable over the period of 10 years. If we compare the proposal with the 2004 tax holiday which was optional for the U.S. corporations. On the April 26, 2017 it was also proposed under the Blueprint that U.S. multinational corporations will be subject to 8.75% tax on their accumulated foreign earnings upon repatriation and payable over the period of 8 years. The purpose behind the another repatriation tax holiday is to end the deferral of taxes by the U.S. corporations and create incentives for corporations so that they could bring more earnings back into the U.S. and use those money for the infrastructure investments. President Trump is also proposing a major corporate tax reform by reducing the corporate tax rate from 35% to 15%, however the Blueprint is proposing corporate tax to be reduced at 20%.

3. RESEARCH QUESTIONS AND HYPOTHESES

Research Questions:

a. How much cash is being held in foreign countries by the U.S. corporations?

b. Which industries would be more aggressive to bring their money back in the U.S. upon execution of another repatriation tax holiday?

c. Why would repatriation tax holiday work now when it did not work in 2004?

Hypotheses:

H1: Corporations facing higher taxes upon repatriating their earnings, withhold more cash overseas.

H2: After 2004 repatriation tax holiday, corporations started to accumulate more earnings overseas.

H3: Higher foreign cash encourage corporations to borrow more money.

4. RESEARCH DESIGN, DATA, AND RESULTS

For my research sample, I selected 30 largest S&P 500 U.S. corporations with foreign subsidiaries. I went to the U.S. Securities and Exchange Commission (SEC) site to review companies 10-K annual reports filings. My research period contains data from the year of 2010 and 2015. From companies 10-K reports, I manually collected data for companies foreign cash, undistributed foreign earnings, repatriation details, debt and their usage, and profit before taxes. My main analysis is based on companies foreign cash and earnings that have been withhold in foreign countries. However, due to limited data availability for foreign cash, I have to make some assumptions which I have explained later in this paper. In 2010, most of the corporations did not separate their foreign cash than their consolidated reported cash, cash equivalents. However during the 2012 FASB meeting, they were highly concentrated on the improvement of corporations effectiveness of disclosure for the financial statements. Cash was one of the factor that they were encouraging corporations to disclose more clearly for the users of the financial statements. It has been observed that many corporations started to report their foreign cash in their footnotes after the 2012.

Variable Descriptions are available as follow:

Earnings Held Overseas: In the 10-K reports, companies are required to report their foreign earnings that have been reinvested permanently in foreign countries or subsidiaries. Companies have yet to recognize the U.S. tax liability on foreign earnings as they are allowed 100% exemption from the U.S. taxes. I found this information in the Income Tax footnote of the financial statements.

Cash Held Overseas: Companies are not required to disclose their cash location in their annual reports, however the U.S. SEC encourage companies to disclose. Companies usually disclose their foreign cash in the Liquidity and Capital Resources section in the 10-K reports. Usually companies state that cash, cash equivalents are being held in the foreign countries or subsidiaries for the liquidity or the investment purposes. Sometimes their foreign cash also includes cash, cash equivalents and short term investments.

Long-Term Debt: The amount of long-term debts or borrowings are being used from companies consolidated balance sheet in the 10-K reports. I observed that most of the companies stated in their footnotes to the borrowings that the purpose of the borrowed money is to pay dividends or repurchase of the shares.

Profits: For the income tax purposes, the earnings reported on the consolidated statement of income before income taxes are being used. I observed that not all companies disclose their domestic and foreign profits separate in their 10-K reports.

For my initial studies I started to collect corporations foreign earnings for the period 2010 and 2015. Per FASB, U.S. corporations are required to disclose their foreign earnings, usually known as undistributed foreign earnings in their annual reports. Corporations usually hold their foreign earnings into foreign countries for investments and further expansion. If corporations repatriate their foreign earnings into the U.S., corporations are liable to pay taxes at the rate of 35% which is usually way higher than the foreign countries, rather corporation elect to defer their tax liabilities. I also noticed that most of the corporations are stating in their annual reports that to calculate their deferred tax liabilities on their foreign earnings are impractical.

Per the Congress Joint Committee on Taxation, it was reported that U.S. corporations are holding almost $2.5 trillion dollars at the end of 2015. Appendix 1 shows the data collections for the total foreign earnings held by the sampled 30 largest S&P 500 U.S. corporations. As you can see that these 30 largest S&P 500 companies itself hold $1.1 trillion dollars of earnings which has been classified as permanently reinvested in the foreign countries for indefinitely. Out of these $1.1 trillion dollars top 10 companies are holding $688 billion dollars of earnings overseas i.e. nearly 63% of the total earnings of $1.1 trillion. The top 10 companies holding the most foreign earnings are Alphabet (google), Apple, Cisco, Exxon, GE, IBM, Johnson & Johnson, Merck & Co, Microsoft, Pfizer.

Appendix 1: Total earnings held overseas by S&P 500 corporations at the end of 2015

Data observation to obtain total earning for held overseas by the 30 largest S&P 500 U.S. Corporations.

Sources: 10-K annual report filed with SEC, 2015, data available for public.

In order to study my first research question on the holding of the foreign cash by the U.S. corporations, I went through cash, cash equivalents details for each of the listed corporations on Table 1. While going through 2010 data collection, I noticed that most of corporations did not disclose their foreign cash separately. Determination or assumption for 2010 was difficult or way more time consuming for this paper. Rather than comparing two years, I later focused on the 2015 year where most of the corporations started to disclose their accumulated foreign cash. Out of my 30 samples, 20 corporations disclosed their cash in their annual report filed with the SEC. Based on the disclosed data of 20 companies, for the rest of the 10 corporations I assumed that for every $1 dollar earnings, corporations are holding $0.64 cash overseas. These 30 companies hold $690 billion in cash overseas at the end of 2015 which is nearly 62% of the total earnings held overseas.

Appendix 2: Total foreign cash held by S&P 500 corporations at the end of 2015

Data observation to obtain total earning for held overseas by the 30 largest S&P 500 U.S. Corporations.

Sources: 10-K annual report filed with SEC, 2015, data available for public.

To leverage my research, I analyze rough estimate for corporations off-balance sheet liability based on the current U.S. corporate tax rate of 35%. Most of the corporations do not provide their deferred tax liabilities as most of their foreign earning are accumulated earnings from the past and it is not practical for them to go back and consider time value and calculate tax liabilities on the past earnings that they have been accumulating. Later I compare their estimated deferred tax liabilities with their foreign cash. The results support my H1 hypothesis that the corporations facing more taxes upon repatriation their earnings, withhold more cash overseas. Appendix 3 shows the better visibility of the results that the flow of the deferred tax and foreign cash is going in the same direction.

In this paper, I also analyze how much saving it can be for corporations if they pay taxes on their foreign earning. As you can see in Table 2 that if these 30 U.S. corporations have to bring their foreign earnings back in the U.S. at the statutory corporate rate, the tax hit on these corporations is in total of $394 billion. While president Trump has proposed one-time mandatory repatriation tax holiday at the rate of 10% than paying 35%. At the rate of 105 these 30 corporations have to pay taxes of $113 billion dollars which is almost one third of the saving on their tax liabilities. It seems like pretty good deal for corporations to bring their foreign earnings or cash back into the U.S. than piling them up in the foreign countries.

Appendix 3: Deferred U.S. tax liability and foreign cash withholding

Sources: 10-K annual report filed with SEC, 2015, data available for public.

One of the question raise here is why corporations are holding so much money overseas. The very common answer is that corporations have better opportunities and savings overseas than in the U.S. and there is no denial for that. One of the major factor of holding money overseas is the higher U.S. corporate taxes. For example, if we look at the tax rates for Ireland, their statutory corporate tax rate is only 12.5% that means corporation’s effective tax rate can be way lower than this or sometime it can be null depending on corporation’s tax planning.

As you can see in Appendix 4 that these 30 S&P 500 corporations are keep holding more money overseas and have reached to $1.1 trillion at the end of 2015 which is almost double of the 2010 holding of $596 billion. These analysis supports my H2 hypothesis that after the 2004 repatriation tax holiday, corporations started to accumulate more earnings overseas. The growth can be for multiple reasons, may be due to more business opportunities in the foreign countries than the U.S. or business inversions to the tax haven countries to save taxes than paying taxes in the U.S. or corporations are holding more money in a hope of another repatriation holiday.

However, I noticed that the growth of the foreign earnings have been slowed down from the 2014, may be corporations need to repatriate their earnings back to the U.S. or they are running out of the reinvestment options in the foreign countries. For example, Exxon Mobil has not changed their undistributed foreign earnings in 2015 than in 2014 i.e. $51 billion; Procter & Gamble has reported $44 billion in 2014 and $45 billion in 2015; United Technologies reported $28 billion in 2014 and $29 billion in 2015.

Appendix 4: Leverage of foreign earnings after the 2004 tax holiday

Sources: 10-K annual report filed with SEC, 2015, data available for public.

In Table 3, I showed more details on the holding of earnings and cash by industry. For example you can see the corporations in Technology and Pharmaceutical sector are holding major portion than the rest of the industry. I used these data to answer my questions regarding which industry is likely to bring more money if another repatriation tax holiday will get executed by President Trump. In Brennan (2014), it has been shown that the corporations that brought the most repatriated amount in 2004 tax holiday were Technology and Healthcare/ Pharmaceutical sectors. It was also evident in my data collection, Appendix 5, that out of 1.1 trillion earnings most of the money is being held by these two sectors. It appears that almost 60% of 1.1 trillion earnings and 90% of $690 billion overseas cash are domain by Pharmaceutical and Technology.

The reason for higher cash and earnings in these sectors can be for multiple reasons. These sectors are high profit making sectors with large size in foreign businesses, easily and low paid foreign labors, potential investment opportunities with higher profitability. These two sectors also holds more intellectual properties which is easily inter transferable within countries. IRS has faced the most difficult time to challenge these type of inter company transactions. Analyzing the full tax breakdown of the Trump tax policy, Durden (2017) is also forecasting that out of estimated $2.5 trillion overseas earnings S7P 500 corporations could bring back $1 trillion dollars mostly in the Technology and Healthcare sectors.

Appendix 5: Data by Industry (Question - which industry would be more aggressive to bring their money back into the U.S. upon execution of another repatriation tax holiday)

Sources: 10-K annual report filed with SEC, 2015, data available for public.

Since the my previous analysis shows that most the money are being held in the Technology and Pharmaceutical sectors, I analyze corporations under those two sectors for their holding of foreign cash with their outstanding borrowings. Many corporations stated in the footnotes to the borrowings that corporations are raising their money to repurchase their own stocks or payments of dividends. Previous studies have been evident that corporations are using their cash as collateral to borrow more money at the less interest rates. As you can see in Appendix 6 that most of the corporations are holding way more in cash than their outstanding borrowings. For example, Apple recently announced that they are borrowing almost $88 billion for shareholders payouts. As you can see in the Appendix 6 that these corporations are holding $1.53 dollars for every dollars they owe. If these companies repatriate their cash back to the U.S., there is a possibility that they would pay off their outstanding borrowings unless there are some restrictions enacted on the use of corporations use of money.

Appendix 6: Cash withholdings and Outstanding Borrowings

Sources: 10-K annual report filed with SEC, 2015, data available for public.

5. CONCLUSION

Many research and studies have been done in past decade on how corporations are holding tons of earnings and cash overseas. And since another repatriation tax holiday is repeatedly being discussed since latest U.S. elections I considered to dig again on the U.S. Corporations foreign holdings. Hence, I collected and analyzed the 30 largest S&P 500 U.S. corporations for their foreign earnings and cash held overseas for the year 2010 and 2015. The collection of data shows that these 30 largest U.S. companies are holding around $1.1 trillion earnings and $690 billion cash overseas at the end of 2015. We can not estimate how much profit or cash these corporations will bring back to the U.S. but we can estimate the tax revenue on these money. If these companies have to bring the money back to the U.S. upon execution of one-time mandatory repatriation tax holiday under Trump presidency, the IRS could collect estimated revenue of almost $319 billion at the reduced rate of 10%.

Under current FASB and SEC, corporations are not required to disclose their foreign cash separately in their 10-K annual reports, however the SEC encourages corporations to disclose this information to their users. Due to the lack of this requirement, I notice a requisition of regulation for corporations to improve effectiveness of disclosure in their annual reports. Implementing this regulation not only give clear information to their users but also helps to trace corporations foreign cash more clearly. FASB should also make a regulation in play for corporations to disclose their foreign and domestic earnings separately.

Analysing data by industry and comparing those data with the prior studies, it supports to my study that Technology and Pharmaceutical sectors are the two domain sector holding most out of the U.S. Hence, it is more likely that if another repatriation tax holiday gets enacted by president Trump, corporations under Technology and Pharmaceutical sectors will be the first ones to step forward to take an opportunity to bring money back to the U.S.

Since the Trump tax plan still in the play in the White House, I have to take many variables into considerations to determine if another tax holiday would be more effective than the 2004 tax holiday. President Trump has not proposed how the U.S. corporations can use their cash or earnings upon repatriation, potential restrictions are unknown. However the observations and from the 2004 tax holiday studies, it is likely that restrictions would be on the repayment of debt, repurchase of shares, and dividends payments (cash or stock). Without these restrictions in the play, corporations would use their money toward shareholders payout. Another repatriation would have the same effect as the 2004 tax holiday.

Another repatriation tax holiday would be just a temporary solution for the corporations tax avoidance in the U.S. For the better alternations I would suggest president Trump to step toward Territorial tax implementation. Territorial tax will be more effective with allowing corporations with exemption for some or all of their repatriation earnings i.e. 90-95% exemption than allowing 100% exemption from the U.S. taxes. If we take this approach, there is a chances to enhance incentive for corporations to invest more at home and abroad.

Table 1

Data for the sample of 30 largest U.S. Corporations

Notes to Table 1:

1. Cash overseas includes cash, cash equivalents and short-term investments from their 10-K report.

2. In 2010, most of the companies have not disclosed their foreign cash. Hence I did not use 2010 for comparison or any analysis.

3. 10 out of 30 corporations did not disclose their foreign cash on the 10-K report, hence I assumed their cash based on the average of 20 available companies’ cash divide by their total foreign earnings which is approximately 64% of their earnings. This assumption applies to Wells Fargo, Verizon, United Technologies, Prudential Financial, Morgan Stanley, MetLife, JPMorgan Chase, IBM, Exxon, Berkshire Hathaway.

4. Pfizer Inc. disclosed that they are holding up to $10 billion of short-term funds in U.S. I assume that $10 billion of $36.41 billions i.e. $26.41 billion are foreign cash, cash equivalents.

5. HP stated in their annual report that majority of their cash is being held outside of U.S. hence I assumed that all their cash, cash equivalents are held overseas.

6. General Motors Co. stated in their annual report that we manage our liquidity primarily at our treasury centers as well as at certain of our significant consolidated overseas subsidiaries. Approximately 90% of our available liquidity excluding funds available under credit facilities was held within North America and at our regional treasury centers at December 31, 2015. Hence, I assume that only 10% of their cash, cash equivalents are held overseas.

7. Ford mentioned in the footnotes to the liquidity and capital resources that "Of our total Automotive cash at December 31, 2015, consolidated entities domiciled in the United States held 84%." Hence, I assume that only 16% of their cash, cash equivalents are held overseas.

8. Merck & Co. stated in their annual report that 80-90% of their cash are in U.S. hence I assume that 20% of their cash balance are held overseas.

Table 2

Tax Savings/Tax Hit

Table 3

Data by Industry for S&P Corporations

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