Repatriation Tax Research Articles

The relation among trapped cash, permanently reinvested earnings, and foreign cash

We investigate the relation among trapped cash, permanently reinvested earnings, and foreign cash. We define trapped cash as cash and cash equivalents generated by foreign earnings and held by U.S. MNC's foreign subsidiaries due to concerns over repatriation taxes, and explain why trapped cash, permanently reinvested earnings, and foreign cash are not synonymous. We exploit the one-time tax rate reduction on repatriated earnings provided for under the American Jobs Creation Act of 2004 to construct a proxy to identify firms with trapped cash. We find R&D intensity, capital intensity, foreign growth opportunities and tax haven subsidiaries are significant indicators of trapped cash. Interestingly, we find firms with tax haven operations are less likely to have trapped cash. These findings highlight the joint role of tax havens as low-tax jurisdictions and offshore financial hubs. Finally, we investigate the relation between firm value and trapped cash. Controlling for excess cash, we find that trapped cash is negatively related to firm value, but primarily for firms with poor governance. Overall, results suggest that our measure is a parsimonious way to estimate the likelihood of having trapped cash that can be applied to a large sample of firms.

The Effect of the U.S. Worldwide Taxation Policy on Domestic Mergers and Acquisitions

This study shows that domestic mergers and acquisitions (M&A) were inhibited by the U.S.’s worldwide tax policy on foreign-earned income. Double Irish structures, a complex web of subsidiaries that reduce foreign tax rates and therefore increase potential repatriation tax rates, are associated with lower levels of domestic M&A by U.S. firms. These results do not reflect a continuation of prior trends or declines in worldwide acquisitiveness and are robust to several econometric approaches. We suggest that the Double Irish variable mitigates a confounding effect in an alternative tax variable that clouds inferences in tests of repatriation taxes and domestic M&A.

Repatriation Taxes and Foreign Cash Holdings: The Impact of Anticipated Tax Policy

We examine whether an anticipated reduction in future repatriation taxes affects the amount of cash U.S. multinationals hold overseas. We find that the expected benefits of a repatriation tax reduction are positively associated with accelerated accumulations of global cash holdings once Congress proposed legislation. Additional tests examining domestic and foreign corporations, voluntary disclosures of foreign cash, and corporate payout behavior support our conclusion that observed increases in excess global cash are driven by changes in foreign cash. We also document that U.S. multinationals accumulating excess cash engage in complementary organizational and financial reporting activities designed to maximize expected tax benefits.

Foreign Cash: Taxes, Internal Capital Markets, and Agency Problems

When the fraction of a firm’s cash held overseas is greater, its shareholders value that cash lower. This goes beyond a pure tax effect: the repatriation tax friction disrupts the firm’s internal capital market, distorting its investment policy. Firms underinvest domestically and overinvest abroad. Our findings are more pronounced when firms are subject to higher repatriation tax rates, higher costs of borrowing, and more agency problems. Overall, our evidence suggests that a combination of taxes, financing frictions, and agency problems leads to a valuation discount for foreign cash and documents real effects of how foreign earnings are taxed.

Repatriation Tax Costs and U.S. Multinational Companies' Shareholder Payouts

ABSTRACTThis paper examines whether and to what extent repatriation tax costs constrain U.S. multinational companies' (MNCs) distributions to shareholders. During the 1987–2004 sample period, I find that repatriation tax costs decrease U.S. MNCs' dividend payments, and the economic magnitude of the effect is substantial. I do not find evidence that repatriation tax costs decrease U.S. MNCs' share repurchases, on average. I find cross-sectional variation in the effect of repatriation tax costs on share repurchases based on U.S. MNCs' opportunities to fund repurchases through external borrowing and to minimize the incremental U.S. cash tax cost of repatriations. I do not observe an association between repatriation tax costs and U.S. MNCs' dividend payments or share repurchases during a more recent time period (2009–2014). This study contributes to our understanding of the impact of the current U.S. worldwide tax system on U.S. MNCs' real decisions and of the determinants of firms' payout policies.

The U.S. Tax and Financial Reporting Treatment of Foreign Earnings and U.S. Multinational Companies' Payout Policies

This paper examines whether and to what extent repatriation tax costs constrain U.S. multinational companies’ (MNCs) distributions to shareholders. During the 1987-2004 sample period, I find repatriation tax costs decrease U.S. MNCs’ dividend payments, and the economic magnitude of the effect is substantial. I do not find evidence repatriation tax costs decrease U.S. MNCs’ share repurchases on average. I find cross-sectional variation in the effect of repatriation tax costs on share repurchases based on U.S. MNCs’ opportunities to fund repurchases through external borrowing and to minimize the incremental U.S. cash tax cost of repatriations. I do not observe an association between repatriation tax costs and U.S. MNCs’ dividend payments or share repurchases during a more recent time period (2009-2014). This study contributes to our understanding of the impact of the current U.S. worldwide tax system on U.S. MNCs’ real decisions and of the determinants of firms’ payout policies.

The Evolution of Corporate Cash

We study the evolution of corporate cash holdings from 1920 to 2014. We show that the recent increase in average cash is not unique but is one of three large magnitude changes in average cash over the past century. However, there are several key differences in modern cash holdings relative to the earlier periods: Earlier changes in cash were broad-based and within-firm; in contrast, the modern run-up in average cash is dominated by cash-rich Nasdaq firms entering the sample, with negative or flat within-firm changes. Moreover, the modern increase in aggregate cash did not start until about 2000.Perhaps surprisingly, we find that estimated relations thought to support precautionary and transaction motives for holding cash are weaker or disappear earlier in the century, when financial frictions were arguably more severe. In general, firm characteristics have little ability to explain time-series changes in average or aggregate cash through the century, but macroeconomic forces, corporate profitability and investment, and repatriation tax incentives help fill this gap.

How Much Do Expatriate Earnings and Repatriation Taxes Matter to Shareholders?

How Much Do Expatriate Earnings and Repatriation Taxes Matter to Shareholders?

Repatriation taxes and outbound M&As

Repatriation taxes reduce the competitiveness of multinational firms from tax credit countries when bidding for targets in low tax countries. This comparative disadvantage with respect to bidders from exemption countries violates ownership neutrality, which results in production inefficiencies due to second-best ownership structures. This paper empirically estimates the magnitude of these effects. The abolishment of repatriation taxes in Japan and in the U.K. in 2009 has increased the number of acquisitions abroad by Japanese and British firms by 16.1% and 1.6%, respectively. A similar policy switch in the U.S. is simulated to increase the number of U.S. cross-border acquisition by 11.0%. The yearly gain in efficiency is estimated to be 108.9 million dollar due to the Japanese reform and 3.9 million dollar due to the U.K. reform. Simulating such a reform for the U.S. results in a yearly efficiency gain of 537.0 million dollar.

Tax Policies, Regional Trade Agreements and Foreign Direct Investment: A Welfare Analysis

In this paper, we develop a partial equilibrium three-country model to examine the relationship between regional trade agreements (RTAs) and foreign direct investment (FDI) in an environment with double taxation. Our analysis shows that FDI is welfare-improving for at least one or both of the two regional countries if wage asymmetry is significantly large. FDI and an RTA are also welfare-improving for the high-wage country and the region if the wage differential is not small. We also examine the role of repatriation taxes in affecting the determination of firm location under an RTA. Our results suggest that the signing of an RTA may induce relocation from the high-wage country to the low-wage country unless an increase in the repatriation tax rate also occurs.

Corporate Responses to the Repatriation Incentive and Domestic Production Activities Deduction of the American Jobs Creation Act of 2004

The 2004 American Jobs Creation Act (AJCA or the Act) was intended to encourage U.S. companies to repatriate foreign earnings and invest them domestically to increase capital spending and employment. We investigate combined effects of two tax provisions, i.e., the repatriation tax holiday and the domestic production activities deduction (DPAD) on domestic investment and payout behaviors. In doing so, we sort repatriating firms based on tightness of capital constraints. We find that the two tax incentives fail to induce non-constrained, repatriating firms benefiting from DPAD to reinvest the capital domestically. Only capital-constrained, repatriating firms benefiting from DPAD increase domestic investment and reduce share repurchases; however, these firms increase cash dividends. Our findings should be useful to policy makers in their considerations to modify the corporate tax structure to increase domestic investment by encouraging U.S. firms to repatriate foreign earnings and reinvest them domestically.

The Value Relevance of Expatriate Earnings and Repatriation Taxes

I analyze data from tax footnotes in the annual financial statements of 772 US multinational companies during 2010-2014. What I term ‘expatriate earnings’ are also known as permanently reinvested earnings (PRE) indefinitely reinvested earnings (IRE), undistributed earnings, and unremitted earnings. By any name, companies can avoid paying the US worldwide income tax on the earnings of their foreign subsidiaries insofar as they do not repatriate, with the result that aggregate expatriate earnings grew at around 10% per year over the past two years to reach an estimated $2.5 trillion as of fiscal years ended in 2014. The filings-review staff of the SEC has, since early 2011, asked over 400 companies to provide (in the future) more-complete 10-K disclosure of information related to expatriate earnings. Accounting standards allow non-recognition of the prospective net tax cost of hypothetical full repatriation of expatriate earnings. Prior research has found that proxies for this mostly unreported data item are value relevant based on regressions to explain levels of market capitalization and on data no more recent than 2004. In contrast, my regressions to explain changes in stock price on 10-K filing dates for fiscal years ended in 2013 and 2014 find that tax-footnote disclosures have no real value relevance. Also, a natural experiment has played out since February 2, 2015 when President Obama released a budget proposal that calls for taxing deemed repatriations of all expatriate earnings. During the ensuing legislative debate, stocks of the half of all US multinationals with higher expatriate earnings have not significantly underperform the stocks of those with lower expatriate earnings.The stereotypical company said to be most exposed to a deemed-repatriation tax is a large pharmaceutical or technology company, but this is not the full story.Actually, few of the most-exposed companies fit the stereotype.

How Much Do Expatriate Earnings and Repatriation Taxes Matter to Shareholders?

How Much Do Expatriate Earnings and Repatriation Taxes Matter to Shareholders?

Microsoft's Foreign Earnings: Tax Strategy

ABSTRACT The high corporate tax rate and the complexity of the U.S. tax code provide U.S. multinationals with the incentives and opportunities to shift income to foreign low-tax jurisdictions. In theory, U.S. corporations are taxed at the statutory rate of 35 percent on their worldwide income, but income earned by an active Controlled Foreign Corporation (CFC) is usually not taxed until it is repatriated to the parent company in the U.S. As a result, trillions of dollars in cash and investments sit in offshore companies, awaiting a repatriation tax holiday. Much of these earnings are held by technology companies. The case looks at Microsoft Corporation, a company with $60.8 billion in unrepatriated earnings as of 2012. The case considers tax havens, nonrepatriation of earnings, cost-sharing arrangements, and transfer pricing and is intended to expose students to the subtleties and complexities of corporate tax strategies. Although the case is set in 2012, the goal of the case is to demonstrate to the students the complex environment in which multinational corporations operate and is independent of any particular tax regime.

What Do Investors Infer About Future Cash Flows from Foreign Earnings for Firms with Low Average Foreign Tax Rates?

This study examines whether investors discount the foreign earnings of U.S. multinational corporations in anticipation of future repatriation taxes. Investor pricing of repatriation taxes has become increasingly important because of the decline in foreign statutory tax rates relative to the U.S. statutory tax rate over the past twenty years combined with the increasing significance of foreign income for U.S. multinationals. Recent comments by regulators suggest they believe current disclosures related to potential repatriation taxes on foreign earnings are insufficient. Consistent with investors pricing repatriation taxes, we observe a significant difference in the earnings response coefficient on changes in foreign earnings of firms with low versus high average foreign tax rates. We also conduct a series of tests to examine whether investor expectations about the likelihood of future repatriation taxes vary as a function of certain firm characteristics. We find no evidence investors differentiate between low foreign tax rate firms based on the likelihood of repatriation.

The Disclosure and Valuation of Foreign Cash Holdings

This paper studies the disclosure and valuation of foreign cash holdings using hand-collected data from 2010 to 2013. The SEC has been commenting on foreign cash in its review of 10-K filings since 2011. I find that the SEC tends to target big firms with limited growth and high permanently reinvested earnings. Conditional on the SEC’s comment, firms with Big 4 auditors are more likely to disclose foreign cash holdings, but firms with a CEO who is also the Chairman and more free cash flow are less likely to disclose. I find no evidence that the value of foreign cash is discounted relative to domestic cash on average, although the value of foreign cash decreases in foreign cash level. Furthermore, foreign cash is less valuable when firms only disclose limited foreign operations in Exhibit 21 relative to the overseas operations collected by the OSIRIS international database and when firms operate in more foreign countries, but more valuable when the U.S. parent controls the decision-rights of foreign subsidiaries and when foreign growth opportunities are higher. There is no evidence that proxies for the repatriation tax are negatively associated with the value of foreign cash. I also examine market reactions to the Treasury Department’s recent crackdown on tax inversions.

Dodging Repatriation Tax - Evidence from Domestic and Foreign M&As

U.S. multinational corporations (MNCs) pay taxes upon repatriation of foreign earnings. This paper investigates whether MNCs facing higher repatriation tax costs are more likely to engage in tax avoidance strategies involving domestic acquisitions. We find that MNCs with higher levels of repatriation tax costs are more likely to engage in both domestic and foreign acquisitions. Furthermore, the positive association between repatriation tax costs and the likelihood of domestic acquisitions is driven by stock-financed acquisitions, and strong corporate governance strengthens this positive relationship. Our findings suggest that domestic acquisitions are a prevalent way for MNCs to access cash trapped overseas.

Territorial Tax System Reform and Corporate Financial Policies

We examine the effect of a permanent change to a country corporate income repatriation tax system on corporate financial policies. In 2009, Japan and the United Kingdom switched from a worldwide system to a territorial system for the taxation of repatriated foreign earnings, effectively reducing the tax liabilities of most multinational firms when repatriating earnings. We find that after the change firms accumulate less cash, pay out larger amounts through dividends and share repurchases, and invest less abroad. We do not find that the tax system change has significantly affected domestic investments even when controlling for capital constraints

The effect of repatriation tax costs on U.S. multinational investment

This paper investigates whether the U.S. repatriation tax for U.S. multinational corporations affects foreign investment. Our results show that the locked-out cash due to repatriation tax costs is associated with a higher likelihood of foreign (but not domestic) acquisitions. We also find a negative association between tax-induced foreign cash holdings and the market reaction to foreign deals. This result suggests that the investment activity of firms with high repatriation tax costs is viewed by the market as less value-enhancing than that of firms with low tax costs, consistent with foreign investment of firms with high repatriation tax costs possibly reflecting agency-driven behavior.

The Economic Effects of Special Purpose Entities on Corporate Tax Avoidance

This study estimates the corporate tax savings facilitated by special purpose entities (SPEs). From 1997 to 2013, we find that firms using SPEs have lower book and cash effective tax rates (ETRs) than non-users. We also find that more extensive use of SPEs is related to reductions in both book and cash ETRs, and estimate the annual cash tax savings for the average SPE user at $10.5 million. These results equate to aggregate cash tax savings between $111 billion and $223 billion for the entire sample of SPE users, or 2.5% to 5.0% of U.S. corporate income tax collections. Finally, we find evidence that SPEs facilitate tax savings by increasing (1) debt capacity, (2) financing for R&D, (3) income shifting across jurisdictions with intangibles, (4) tax credit and loss duplication, and (5) repatriation tax deferrals. Collectively, these findings provide economic insight into the magnitude and mechanisms of SPE-based corporate tax avoidance.