Earlier this month, Microsoft borrowed $2.25 billion in unsecured debt. What in the world possesses a company with $40 billion in cash and short-term securities to go out and borrow money?
Rock-bottom interest rates are one reason. But the bizarre, byzantine U.S. tax code seems to be another.
The U.S. is the only major country that taxes foreign earnings of its own companies this way. American investors may not come out ahead either.
Microsoft declined to comment on whether its recent borrowing was partly driven by tax considerations. But, like many purportedly cash-rich companies, Microsoft can't bring home much of its cash without writing a fat check to the Internal Revenue Service.
Politicians have been carping about the more than $2 trillion in cash sitting idle in corporate coffers even as unemployment remains high. But much of that cash isn't in the U.S.; it is abroad. And it isn't likely to come back home unless U.S. tax laws change.
David Zion, a tax and accounting analyst at Credit Suisse, estimates that the companies in the Standard & Poor's 500-stock index have "north of $1 trillion" in undistributed foreign earnings, or profits that have been parked overseas to avoid U.S. tax. Not all of that is cash; some is in the form of inventories or other assets.
U.S. companies are taxed at up to 35% when they bring home the earnings generated through the operations of their overseas subsidiaries. They get a credit for any taxes paid to foreign governments—but, since the corporate-tax rate in the U.S. is one of the world's highest, most companies are in no rush to bring the money back onshore. By keeping those earnings abroad, U.S. companies can indefinitely defer their day of reckoning with the IRS.
That can put firms in the peculiar position of having tons of cash offshore that they might need but can't use at home without taking a tax hit.
The U.S. is the only major country that taxes foreign earnings of its own companies this way. American investors may not come out ahead either. In a 2007 survey of executives at more than 400 companies, Massachusetts Institute of Technology economist Michelle Hanlon found that the desire to avoid the repatriation tax led to a variety of distortions, most of which end up making companies less efficient.
For example, among the companies that had brought some profits home to the U.S., 30% had invested in lower-returning foreign assets rather than pay additional taxes to bring overseas profits back onshore. Another 56% had borrowed money in the U.S. rather than bring cash home. And 6% said they had declined to invest in a profitable project in the U.S. when funding it with foreign earnings would have triggered a tax hit.
These perverse effects can extend even to smaller companies. Consider Waters Corp., a laboratory-instrument manufacturer based in Milford, Mass. At last count, Waters had approximately $1.4 billion in earnings locked up at foreign subsidiaries. Of the company's $830 million in cash and short-term securities, around 80% sits abroad.
Waters borrowed $200 million last year to pay down higher-cost debt and "for general corporate purposes." Like many U.S. companies, Waters is "building up cash outside the U.S. while borrowing in the U.S.," says Eugene Cassis, its investor-relations director.
"We'd certainly like to be able to bring some of that money back," he says. "We would have a greater ability to invest here if we didn't have to pay a 'tollgate tax' to bring the cash home. Current tax policy creates a slight bias towards acquiring technology or assets outside the United States."
As the great financial analyst Benjamin Graham long argued, shareholders are usually better off when companies hold less cash, rather than more. Too much cash can lead to reckless acquisitions and a fat-and-happy culture of waste.
But, in this case, it isn't just management that is making companies sit on too much cash. It is tax policy, too. Congress and the White House are discussing whether the U.S. should follow the rest of the world and stop taxing repatriated offshore earnings from companies that already have paid taxes to foreign governments. Some gnarly technical details will have to be worked out if the repatriation tax is to be reduced or eliminated.
Meanwhile, investors should remember that a big chunk of cash on the balance sheet may look tempting but isn't necessarily there for the taking.
— intelligentinvestor@wsj.com; twitter.com/jasonzweigwsj
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