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Apple headquarters in Cupertino, Calif.

Paul Sakuma, Associated Press

ABOUT THE AUTHOR

Charlie Kelley, CFA, is a portfolio manager and founder of Compass Capital Management in Minneapolis. His e-mail address is kelley@compasscap.com.

Business Forum: Fix the nation's corporate tax code

  • Article by: CHARLIE KELLEY
  • November 25, 2012 - 11:32 AM

Medtronic has more than $10 billion in cash and cash investments on its balance sheet, yet it has to borrow money for its stock buyback program. Why? Because 94 percent of the company's cash and cash investments are overseas.

Donaldson Co., with more than 80 percent of its operating income generated outside the U.S., has virtually all of its $318 million in cash and short-term investments deposited offshore, a situation that clearly complicates the calculus of its own stock buyback and dividend policies.

Cash might be king, but as far as U.S. corporations are concerned, cash is all too often an exiled monarch. For example: Apple Inc., with nearly $122 billion in cash and cash equivalents on its balance sheet, reported in a recent filing that $82.6 billion, or 68 percent, of its cash is parked overseas. Microsoft: $67 billion in cash and cash equivalents, more than 80 percent of which is offshore. Cisco: 90 percent of its $48.7 billion -- almost $44 billion -- overseas.

All these companies, international enterprises with extensive operations in Europe, South America and Asia, have a problem. If they bring any of the cash they generate overseas back into the United States, it will be taxed at rates as high as 35 percent, a corporate tax rate that is one of the highest in the world.

As a result, while U.S. corporations hold an estimated $2 trillion in cash on their balance sheets, many are unable to efficiently put their cash to work because it's trapped on foreign soil. Even though they're able to take a tax deduction for the foreign taxes they pay, moving that cash back to the U.S., for whatever reason, is not in the best interest of shareholders simply because it's too expensive to do so.

This means that companies seeking to build market share in the U.S. -- either through acquisition or organic investment -- may turn away from the opportunity because they don't have the cash or can't make such a strategy work with borrowed money.

Locating jobs overseas becomes more attractive as low foreign tax rates more than offset the sometimes-higher costs of offshore operations.

And the economics of buying and expanding overseas becomes more attractive. Just this past September, for example, Medtronic announced it was acquiring Kanghui Holdings in China in an $816 million all-cash deal. Last year, Microsoft used $8 billion of its offshore cash to buy Luxembourg-based Skype, barely putting a dent in the $42 billion of foreign cash the company had overseas at the time.

The distortion the U.S. corporate tax code creates doesn't stop there. Consider the issue of a company's dividend policy and stock buyback program, a key element contributing to a company's stock price, and also a way for companies to circulate cash back to shareholders and back into the economy.

Bloomington-based Donaldson, which has a long-standing buyback program and like clockwork has raised its dividend year after year, is nonetheless trading at a current dividend yield (dividend divided by stock price) of just over 1 percent. One would guess that Donaldson's board is acutely aware that dividend-paying stocks are in high demand in this decidedly choppy market, especially those paid by solid, profitable companies such as theirs.

Yet it's difficult to justify a higher dividend payout or a more aggressive stock buyback program if the company, lacking sufficient domestic cash reserves, is forced to borrow to do so, imprudently leveraging its balance sheet and limiting its flexibility to execute its strategic growth plans.

Medtronic, meanwhile, is faced with a potent competitor in Covidien, a Dublin-based company operating in a nation with a 12.5 percent corporate tax rate, described in a recent report by the accounting firm Deloitte as "the cornerstone of Ireland's industrial policy."

Covidien in 2010 bought Plymouth-based EV3, which competes head-to-head with Medtronic in the vascular device market. And just last month, Mallinckrodt, Covidien's Missouri-based pharmaceuticals business, acquired CNS Therapeutics Inc., of St. Paul, for approximately $100 million. Clearly, it's easier for cash taxed at 12.5 percent to swoop into a country where it's taxed at 35 percent.

There seems to be agreement on both sides of the political aisle that our corporate tax structure is broken. Our high marginal rate, coupled with the unevenness with which our corporate tax code is applied, is hampering our competitiveness both here and abroad. It's drawing jobs away from our shores to more tax-friendly nations, and it's giving foreign-based competitors, themselves flush with cash, a competitive advantage both here and overseas.

The solution is not simply a tax holiday or a lower rate but fundamental federal corporate tax reform that removes the unintended exile of corporate cash from U.S. shores. That requires fundamental changes to the tax code and the political will to do it.

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