U.S. companies taking advantage of a widely used
tax-avoidance maneuver face a ticking clock as the days of ultralow interest
rates, courtesy of the Federal Reserve, are numbered. Since 2008, the Fed's
easy cash policies have allowed companies to buy back stock, pay dividends and
make acquisitions largely without tapping cash from overseas subsidiaries. By
leaving foreign profit overseas, companies avoid the sting of the U.S.'s 35%
federal tax rate on it.
The result is a peculiar situation in which U.S. companies
simultaneously have issued record amounts of debt—both in nominal terms and as
a percent of gross domestic product—and hold what appears to be record amounts
of cash overseas. U.S. companies borrowed another $223 billion in the first
quarter of the year. But the technique may be on borrowed time. It is likely to
lose some luster as the Fed's easy-money policies cool and Congress revisits
tax rules that encourage businesses to stockpile cash overseas and even to
relocate to low-tax countries.
And as rates tick up, the risk accompanying all that debt
rises as well. Too much debt on its own can weaken debt ratings and make
investors jittery. And a crisis or a downturn—whether economic, industry wide
or company-specific—could hamper a company's ability to make interest payments,
or to repay or refinance the debt as it comes due.
Corporate-tax rules are already getting official scrutiny
after a recent rash of corporate "inversions" in which companies
merge with overseas companies to gain lower tax rates and tap offshore cash. President
Obama and other administration officials have criticized inversions, and called
to retroactively ending the tax benefit. Few corporations publicly say they are
borrowing to avoid a tax hit, but analysts and economists say the dynamic is
Federal Reserve Chairwoman Janet Yellen earlier
this month deflected questions about tax policy and overseas earnings, saying
it was the responsibility of Congress and the White House.
By law, the Fed considers three objectives when setting
monetary policy, including interest-rate targets: controlling inflation,
maximizing employment and moderating long-term interest-rates. But the
unintended effects of its policies can be much more diverse. Easy money ahead
of the financial crisis helped run up the price of everything from forest land
to housing. This year, Fed officials have expressed concern that, in the long
run, low rates may again be inflating the value of assets and encouraging risky
Another effect may be tax avoidance. There are no
comprehensive numbers on foreign cash and liquid securities held by U.S.
companies, but Moody's MCO -0.36% Analytics estimates that
some $950 billion in cash is held offshore by the more than 1,100 nonfinancial
companies whose debt it rates. That accounts for more than half of the record
$1.64 trillion in cash held by the companies at year-end.
Companies have been accumulating cash at a rapid clip,
doubling it since 2007, according to S&P. Meanwhile, the debt taken on by
nonfinancial companies reached a record $9.6 trillion in March, up from $6.5
trillion in early 2007. The first-quarter figure set a new high since at least
1955 in both absolute terms and relative to the economy as a whole, at 57% of
gross domestic product—the sixth consecutive quarterly record, according to
data from Moody's.
That debt not only allows companies to keep profits untaxed
overseas, it also generates interest costs that can be used to generate tax
deductions at the higher U.S. rate.
But when S&P looks at corporate balance sheets it
doesn't fully value cash held overseas in its ratings calculations. The ratings
company discounts offshore cash by about 25% on average, an estimate of how
much companies would have to pay to Uncle Sam if they brought the money to the
U.S. That S&P considers corporate cash at all when measuring a company's
indebtedness is itself a sign of how unusual the times are: Until recently, the
company saw no need, because big borrowers rarely had big cash hoards too.
Among more than 240 companies disclosing increases in
unremitted foreign earnings in 2013, those with bigger increases tended to also
see bigger increases in corporate debt, according to data from research firm
By borrowing at home, companies can do things like buy back
stock—generally done from a company's home country—without taking the tax hit
to bring offshore cash to the U.S. parent.
Rising foreign cash holdings correspond to a growing share
of earnings derived from outside U.S. borders as companies expand around the
globe. And the figure is rising, too. And, of course, low interest rates make
it a feasible strategy to borrow against those untapped profits.
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