By Joseph Neu
With the US presidential election decided, the US now is watching with interest the political theater surrounding the so-called fiscal cliff negotiations. There are many concerns (see related story), but the negotiations that may matter more to treasurers of US-based multinationals are those concerning how much offshore earnings will be taxed (regardless of their designation as permanently reinvested) and what they can get in return for paying this tax.
Revenue Neutral no more
With President Obama’s reelection, fiscal negotiations require a “balanced “approach to deficit reduction—meaning new revenues in addition to spending cuts. In the context of tax reform, this means the revenue-neutral mandate has become more of a revenue-positive one. Indeed, the mandate may now even include a requirement for higher nominal tax rates. One way or another, US multinationals will be asked to contribute more to the US fisc. And a clear way to do this is to tax offshore earnings currently, which would effectively raise the tax rate on them from near zero to something more.
A sure sign that this is on the Administration’s radar screen is seen in the increase of studies and articles in the financial press highlighting the low effective tax rates paid on offshore earnings and the substantial offshore cash positions (i.e., retained offshore earnings) of certain US MNCs.
Regulators are also reflecting this interest with SEC calls for more disclosure on the extent and nature of offshore cash positions, including their amount and classification as permanently reinvested.
All this paints a target on offshore earnings and cash generated from them as depriving not only the US Treasury, but US investors from information pertinent to their investment decisions. These accusations now join the principal one used by those looking to tap US MNCs’ foreign earnings; namely that they are depriving US job-seekers of domestic direct investment and jobs.
As this reality sinks in tax reform negotiations that will begin in earnest next year will center on one question: What can US MNCs get in return for the tax revenue contribution they will be asked to make? Of course, US corporates generally will still fight to minimize tax rates, but at some point the balance of negotiations will involve a revenue trade.
Competing interests
Complicating these negotiations further, just as with the current fiscal cliff bargaining, is that there are various constituencies that will push for different things and vary on what they ask for in return. For example:
- Tax vs. liquidity planners. Whereas tax directors may be focused on negotiating in order to mitigate the effective tax increase (via loopholes and deductions) as well as the optics of nominal rate increases, treasurers should weigh in to get liquidity utilization in the mix of “asks” US MNCs lobby for in return for paying up on offshore earnings.
As more cash builds up in places where it is trapped for other reasons, it simply becomes more valuable to free cash trapped by the US tax code.
- Offshore cash-rich MNCs vs. more domestic-focused US corporates. Firms with increasing earnings and cash offshore (e.g., tech and pharma) will have different trade-offs than US corporates with larger domestic earnings and lower offshore cash balances (e.g., retailers and transportation firms). Already, efforts to shift the US to a territorial-based tax system need to account for more domestic-oriented firms that value a lower corporate rate more than allowing offshore earnings to escape US taxation.
As it becomes more difficult politically to get a lower tax rate without finding new revenue, it is more likely that domestic-focused firms will be pointing to offshore earnings in their tax reform negotiations. Unfortunately, this means that MNCs should lower expectations for a pure territorial regime to be part of forthcoming tax reform. It also means that policy-makers will attempt to divide and conquer US corporate interests.
While treasurers at US MNCs are more likely to get caught up in the implications of the second bullet, in line with last month’s column, it shouldn’t overshadow the effort to benefit liquidity management in both tax reform negotiations and the planning that goes with it.