Guest post: Tax Repatriation Day
I’m delighted to have my first guest blogger!
“FogOfWar” (named after the documentary) is someone I’ve known for some time who comes from a mathy background, with a detour through accounting, tax & law winding up in banking (not as a quant). FOW & I have jammed finance policy many times and we tend to agree on a lot of things–I hope it will bring a “what really happens on the ground” perspective to thoughts about modeling as well as some useful insight into some of the technical rules (like accounting) that can matter a lot. Here’s his post:
The NYT ran an article on tax repatriation yesterday. Often, as someone in the industry, these articles can be infuriating for their lack of accuracy, misdirection or imprecision. In this case, however, my hat is off to the NYT for some damn fine traditional journalism. They’ve taken a fairly complicated issue (one I happen to know more than a little about), understood the core points in play and laid them out in an interesting, informative and readable article. Yes, it really is as bad as they make it out to be.
The “repatriation holiday” makes my vague-and-unofficial list of “10 worst tax ideas out there”. Unfortunately, every bad idea ultimately finds its way to Congress & this one is back for seconds. The NYT article lays out the case well, but here’s are two additional reasons on why this idea seems to have lasting appeal, which come in the form of catchy phrases:
“The money is trapped overseas”
We all know what “money”, “trapped” and “overseas” mean, and we can form an immediate idea of how this would be a bad thing, and how freeing that trapped money and bringing it back to the US would be good for the economy. Thus we get the inference: “The money is trapped overseas, and if we could bring it back it would create jobs.” Unfortunately, the second half of the second sentence is completely false. A more accurate sentence would be “The money is trapped overseas, and if we could bring it back corporations would pay slightly larger dividends this year, but not create any jobs or invest in any US plants that weren’t already in their strategic planning.” Doesn’t have quite the same ring to it…
Not nearly as catchy as the first phrase, and uses two words for which most people don’t have a quick definition (at least not when paired together). Relevant, however, and a quick wonkish example with illustrate the thrust:
Let’s take a hypothetical US company, called (just to pick a name at random) “Lehman Holdings”. Lehman Holdings has assets claimed at $900 on its books and debt of $800. Lehman Holdings also owns 100% of another company, who we’ll call “Lehman UK”, which has assets claimed at $100 on its books and no debt. So, at first blush, one might think that Lehman has a 20% equity buffer: $1,000 of assets and $800 of debt (or a 4:1 debt ratio). This is nice easy math, which happens to be wrong in practice. The hidden assumption is that the people who loaned Lehman Holdings $800 can get access to all $1,000 of assets. They certainly can access the $900 of assets (or whatever they’re worth by the time bankruptcy hits), but the UK subsidiary is subject to UK bankruptcy rules, not US bankruptcy rules. Thus, when US creditors try to pull the $100 of assets out of the UK, they may find it’s more difficult than they anticipated (international bankruptcy gets sticky fast). Perhaps they could sell the stock of the subsidiary, but in real life that would involve untangling a whole host of interconnected contractual arrangements between Lehman Holdings and Lehman UK, which could take years. Not to mention the fact that to pull the $100 back, they’d have to pay ($35) in US taxes, so really there may be only $65 net to work with (other facts could zero out the tax bill). Probably in the end they can get the $100 of assets ($65 post taxes), but it can mean a significant time delay, and when you’re dealing with an imminent default, delay in action can translate to financial loss.
So, for all of these reasons, having $100 in a subsidiary isn’t worth quite the same thing as having $100 in the parent company. The fancy name for this is “structural subordination”, a term used by the credit rating agencies. So, if you’re a tech or pharma company with many billions of USD in your tax-shelter Irish/Dutch/Singapore subsidiaries, this can become a problem for your credit rating (which can impact your cost of borrowing). It’s probably not the primary reason for the lobbying efforts on tax repatriation, but it is definitely a factor, as the ($35) in tax is what’s preventing Holdings in the above example from pulling the $100 out of UK.