On Sunday, August 14th, CBS’s 60 Minutes featured a story on U.S. business practices that are keeping $ 60 billion dollars a year offshore, “The New Tax Havens: Do Companies Pay Their Fair Share?” Long-term Houston companies, Transocean and Weatherford, were featured in the story. Both companies have relocated to Zug, Switzerland, which was described by Leslie Stahl as a “tax haven within a tax haven” with an attractive corporate rate of between 15% and 16%. Zug has a population of 26,000 and it is the company home to 30,000 businesses, a number which is increasing by 800 a year! Because of U.S. laws and accounting rules, it has become a very attractive venue for U.S. businesses. Bill can be reached via email or at 713.622.1120.

Congressional Concerns

According to the Texas Congressman Lloyd Doggett (D-TX25), Transocean emigrated to Zug two years ago, but it still has 1,300 employees in the Houston area verses the 12 or 13 people in Switzerland.  Expatriating saved the company $2 billion in U.S. taxes.  Weatherford has 2,800 people in the Houston area and only a mail box office in Zug.    

Congressman Doggett has proposed legislation to tax businesses not based on where they are incorporated, but where their decision makers and management actually reside and make decisions.  Doggett’s proposal, the International Tax Competitiveness Act of 2011, (H.R. 62) was critically reviewed by the New York Bar Association's Tax Section.  "Let them pay the same way that other Houston-based companies pay. And so, if they have their management and control here, they ought to be paying (taxes) in the United States. I think it's fair," Doggett argues.  Faced with the mere threat of Doggett's legislation, Transocean and Weatherford both recently packed up their top brass and shipped them to Geneva.

Some have argued that companies should be evaluated on earnings before interest, taxes and depreciation (EBITD).  To a CFO, it is not the only yard-stick that is important -- taxes affect earnings per share and impact cash flow.

Speaking about the U.S. tax system, “We are dealing with a tax system that is a dinosaur," Cisco CEO John Chambers told Stahl.  He's been expanding Cisco overseas because of growing demand abroad, but also to lower the company's taxes – Cisco’s average tax rate over the last three years was just 20 percent.  Through deferral of U.S. tax on un-repatriated earnings and accounting rules (APB 23), which provides a similar financial statement result, businesses can manage their U.S. tax and financial profits.  Why should U.S. multinationals pay U.S. tax (or provide for such taxes) on earnings that will be redeployed in foreign markets?

Economist Martin Sullivan says it is standard operating procedure for companies like Cisco. "U.S. multinationals are shifting their research facilities, shifting their manufacturing facilities, and shifting some regional headquarters into Switzerland and into Ireland. And those are massive numbers of jobs," he told Stahl.  Sullivan says Ireland taxes corporations at just a third (12.5%) of the U.S. rate, so no wonder the outskirts of Dublin look like Silicon Valley. Many well-known companies are all but obliged to go abroad.

"Six hundred American companies are in Ireland and they employ 100,000 people," Stahl pointed out. "Those are jobs that aren't here (in the United States). And they moved to Ireland because of taxes."  When a formula or a computer code is registered abroad - say in Zug - a U.S. company is allowed to claim (that) a lot of its taxable profits are there (Ireland), even if most of its sales are in the United States.

Economist Sullivan told Congress (in testimony worth reading) that these patent and profit transfers are accounting tricks that have allowed companies to chip away at the 35 percent U.S. tax rate and save tens of billions of dollars. He says that from 2007 to 2009 these maneuvers helped lower Pfizer's average tax rate to 17 percent, Merck to 12.5 percent, and GE to just 3.6 percent.  In his testimony before the House Ways and Means Committee, he described our plight graphically:  the “tax code is dead weight on the shoulders of the American economy.”

"We leave the money over there. I create jobs overseas; I acquire companies overseas; I build plants overseas; and I badly want to bring that money back," John Chambers told Stahl. 

Options

In 2010, the “Report on Tax Reform Options: Simplification, Compliance and Corporate Taxation” (Volker Report) was released by the President’s Economic Recovery and Advisory Board.  It considered the fundamental issue of whether foreign operations of U.S. companies operate at the expense of domestic businesses or whether they are complementary.  It reported that,

Most experts agree that the current hybrid U.S. system that combines a worldwide approach (to taxation) with deferral (no U.S. tax until funds are repatriated) embodies the worst features of both a pure worldwide system and a pure territorial system (under which the United States would not tax foreign income or provide a foreign tax credit)…

The report reviews the pros and cons of various options.  One includes lowering corporate tax rates (to say 28%) and sacrificing deferral.  Another option would end deferral and maintain the current tax rates.  Also considered are (i) moving to a territorial system or (ii) limiting or ending deferral at the current U.S. tax rate.

Chambers told Stahl that Cisco has almost $40 billion overseas that could be brought back to the United States.  The total amount of money U.S. companies have trapped overseas is $1.2 trillion. Chambers is advocating for a one-time tax break to allow them to bring that money home at a rate of, say five percent. That would, he says, stimulate the economy and create jobs.

But the Obama administration has opposed this idea. When it was tried in 2005, the Treasury did rake in billions of dollars, though very few jobs were created, according to the 60 Minutes report.   This an interesting comment because the special dividend received deduction of IRC § 965 included the required “reinvestment of the dividend in the United States … including as a source for the funding of worker hiring and training, infrastructure, research and development, capital investments…”  Rather than considering such a program, President Obama seems to be committed to higher taxes for individuals and corporations.

"What if tomorrow Congress passed a quickie law and the tax rate was 20 percent? Would that solve everything?" Stahl asked Chambers.  "I think it is the most important ingredient that we have to think about being competitive," Chambers replied. 

According to Bill Leary, MFR Director, more is involved than just looking at the foreign income tax rate on corporations .  You have to consider income subject to tax, incentives, treaty networks, social taxes, customs duties, and VAT (a significant source of tax revenues borne by domestic consumers).

If "you lower the rate from 35 percent to 20 percent,  you lose something like $2 trillion in taxes. We have a horrible deficit crisis and debt crisis. That's almost too much money to lose. What's your answer to that?" Stahl asked. "My answer's very simple: every other developed country in the world has already done this. I'm not asking to give me a favor, or a hand out," Chambers replied. "All we're asking is: give us a level playing field."

If you apply a static revenue model to a repatriation holiday, it appears costly.   To evaluate its real world impact, we need to remember that such a change will impact our behavior.  Offshore funds will stay offshore if we don’t provide an incentive for repatriation or end deferral – they will remain outside the reach of the IRS.   Without government action, these earnings could be used in the United States to stimulate the economy, create jobs, and generate tax revenues.

How have other countries reduced their tax rate?  Over 30 years ago, Nobel laureate Milton Friedman and his wife Rose published Free to Choose – A Personal Statement.   Their suggestion is to re-focus the scope of government, reduce laws that tinker with public decision making and limit well intended spending.  Setting the focus for his book is a quote by Supreme Court Justice Louis Brandeis: “Experience should teach us to be most on our guard to protect liberty when the government’s purposes are beneficial…The greater dangers to liberty lurk in insidious encroachment by men of zeal, well-meaning but without understanding.”

In Governor Rick Perry's  (R-TX) announcement of his decision to run for President, he reminds us that that every tax dollar represents effort and labor of an individual or business through hard work and sacrifice.  Out of respect for its citizenry, governments should keep tax laws straight-forward, rather than filled with exceptions and incentives, and rates as low as possible.