Tax Analysts Blog

How Important Is Deferral to Multinationals?

Posted on Apr 22, 2013

The U.S. tax system allows multinationals to effectively indefinitely defer taxes on profits earned by active foreign affiliates until that money is repatriated to the United States. Deferral as a cornerstone of tax policy dates from a compromise during the Kennedy administration and has long been viewed as a key element of the international tax regime. But the Senate Finance Committee doesn’t think it’s all that important. In a background paper released earlier this month, Finance said, “In general, changes in the timing of paying a tax do not impact financial income and, as a result, may not significantly affect business behavior.”

This strange statement understates the importance of deferral and might show that the Senate, at least, is unprepared for the fight that would result from an attempt to repeal or limit multinationals’ ability to avoid taxes on foreign profits. There’s a reason that Tax Analysts' Amy Elliott referred to this as the scariest tax concept being peddled in Washington.

U.S. multinationals have over $1 trillion in cash and short-term investments in offshore holding companies, according to The New York Times. The Times blames the 2004 repatriation holiday for encouraging companies to keep their foreign profits offshore until a second holiday is approved by Congress. Business seems to be waiting for the next round, despite the first repatriation bill being sold as a one-time-only offer. But the truth is that multinationals have always stored cash outside the United States. Over $300 billion was repatriated in 2005 to take advantage of the holiday, which allowed companies to pay only 5 percent in taxes on money brought back onshore (most of which was used to pay for stock buybacks and not new job creation or investment), so large amounts of cash were already offshore before the 2004 legislation.

If deferral of taxes wasn’t that significant, there would be little incentive for businesses to keep profits earned by active foreign subsidiaries offshore. As the Times and others have shown, however, businesses do hoard cash overseas. The Finance Committee argues that because they must book tax on those profits for purposes of financial reporting, eliminating deferral would only affect cash tax rates, which aren’t that important. It is very likely that taxwriters have this point wrong.

And if so, it’s probably a case of deliberate blindness, or perhaps just naïve optimism. Eliminating deferral could raise $10 billion a year, says the Congressional Budget Office. That’s probably a conservative estimate. Policymakers need revenue to pay for a corporate rate cut if such a package is going to be revenue neutral. Deferral is a big target, and cutting it back is probably easier for Congress to stomach than eliminating section 199 (which is supposed to encourage domestic investment, while deferral encourages foreign profit-making) or depreciation. Corporate tax expenditures are hard to find, and those that would pay for a significant rate cut, say to 25 percent, are even rarer. When the Finance staff says that businesses don’t really care about deferral, it seems more like a wish or hope than an accurate representation of corporate thinking.

In fact, there is abundant evidence that multinationals care a lot more about deferral than they do about a lower corporate rate. Many companies with significant foreign profits pay much less in taxes than the nominal rate of 35 percent suggests. Aggressive profit shifting, deferral, and leaky transfer pricing rules (combined with targeted tax provisions like section 199, the research credit, and bonus depreciation) have reduced the effective foreign tax rate to around 12 percent. And there isn’t parity across industries. Multinationals and companies with large amounts of intangible income pay much less than domestic manufacturers, for example. For companies like Apple, Google, and big pharma, the ability to hoard cash offshore tax free is a lot more valuable than a slight reduction in their already low corporate tax burden.

Senate taxwriters are right to target deferral for elimination in tax reform. It produces inequities between domestic and multinational companies and is hard to justify with corporate receipts at an all-time low. But lawmakers need to be realistic about how difficult it will be to sell such a change to businesses and their lobbyists. Simply saying something is unimportant doesn’t make it so.

Read Comments (1)

thomas beckettApr 22, 2013

This is an absolutely vital issue for the tax community and the country as a
whole. Deferral will always have it's defenders because it saves corporate
America billions of dollars. I get that. But deferral is also the enemy of
common sense and rational tax policy. It largely explains why we have this
ridiculous gap between the statutory rate and the effective rates firms
actually pay -- and why tax outcomes vary so widely on foreign income versus
domestic income. Frankly, deferral does tremendous harm to our economy in terms
of the perverse incentives it creates. I'd be perfectly happy to allow US
multinationals to be taxed at a very low rate (say 18%) if, in exchange, we
could dump deferral and tax all corporate profits (foreign and domestic) on a
current-year accrual basis. The resulting system would be globally competitive
due to the low rate and, critically, it would eliminate the present system's
bias favoring foreign investment relative to domestic investment. Tax Notes has
published many excellent articles over the years addressing this very point:
deferral w/repatriation amounts to a "tax subsidy" for capital deployed
overseas. Why on earth would a country encourage that when the domestic
unemployment is chronically high and "job-less recovery" has become the new
normal? Also, the tax system would be greatly simplified under accrual; entire
layers of complexity would just go away. As for the sanctity of the 1962
compromise that gave us subpart F, that was thrown under the bus more than a
decade ago when Treasury caved on check-the-box. Today's reckless,
turbo-charged deferral is nothing like what JFK signed up for way back when.
Time for an overhaul that restores sanity.

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