The Fight to Bring Back Corporate Cash
Violations of U.S. tax laws can lead to both civil fines and criminal prosecution for the corporate managers and their legal counsel who designed these schemes. In the case of OSG, the company’s tax counsel was sued for negligence in the bankruptcy. OSG’s tax lawyers then sued OSG’s senior executives. The competing claims were eventually settled, but none of this has created any value for OSG’s shareholders, much less any new jobs.
The 2017 tax law begins a new regime for future corporate taxes, but it may also compel recognition of huge past-due tax liabilities. All previous offshore corporate tax avoidance scams will now be exposed to IRS review. Dow and General Electric were required to pay back taxes, interest and penalties (up to 60 percent in Dow’s case). Dow and General Electric, however, escaped the criminal prosecution other corporate managers (and their legal counsel who designed these schemes) have faced.
The process of reconciling offshore revenues is going to be exceeding painful for corporate managers and investors alike. Fessing up to past acts of tax avoidance is hardly likely to result in a wave of new corporate investments that increase productivity and economic growth. Indeed, while the process of coming to Jesus in the world of offshore financial partnership may generate a lot of revenue for the U.S. Treasury, it is unlikely to boost corporate investments or even result in the actual return of cash to the United States.
Some investors are already anticipating that the tax legislation will result in a bonanza of stock repurchases that will boost share prices above current levels, but in fact the opposite may be the case. With an appropriate level of enforcement by the IRS, the notion that a lower tax rate on future revenue will lead to increased levels of cash for U.S. corporations that are compelled to come forward and confess their sins with respect to past tax returns and financial disclosure seems fanciful.
Many economists will be surprised to learn that the new tax bill does not actually require repatriation of offshore cash. Treasury is instead employing “deemed repatriation,” which means the IRS taxes you on your unrepatriated foreign earnings whether you bring the cash back to the United States or not.
Taxes will be applied over eight years in an end-weighted formula which means you make your biggest payment, roughly 25 percent of taxes due, in year eight. The tax rates reportedly will be 15.5 percent on cash balances and 8 percent on non-cash balances. Just imagine what a compliance nightmare this creates. What is the definition of "cash"?
More astute corporate managers and legal counsel who have participated in past tax avoidance transactions may approach the IRS and try to cut a deal. We could even see a formal tax amnesty proposed by the Trump administration, but Washington insiders give such an idea long odds in the near term.
“Treasury would consider offering an amnesty only if corporations evinced a real fear that they were about to be caught up in its maw,” notes one respected tax analyst in Washington. “I’m not 100 percent sure we are there yet. We did this with Swiss bank accounts only when we had them dead to rights.”
Treasury is already working on the implementing regulations for this “virtual repatriation.” Another veteran Washington observer says that earnings return provisions of the tax bill are the highest priority item, followed by the anti-base erosion provisions, and then the worldwide regime on Global Intangible Low Tax Income—with a great acronym, “GILTI.”
In theory, Treasury is going to put in place the deemed repatriation rule to raise the roughly $200 billion over ten years they need to move to a system which excludes most foreign-sourced active business income from U.S. taxation. This is the aptly named “participation-exemption system” that the American business community has been lobbying to get for years.
But of course none of this is likely to result in a wave of new investments or job creation—unless you are a tax lawyer or consultant. One way or another, Treasury is going to collect its money. Perhaps that’s how House Speaker Paul Ryan plans to cover the increased deficits intentionally implemented by the new tax legislation. And for all of you economists and hedge fund moguls who think that the new tax legislation will result in a cash repatriation bonanza that will benefit stock prices or the economy: better think again.
Richard Christopher Whalen is an investment banker and author who lives in New York City. He is Chairman of Whalen Global Advisors LLC and focuses on the financial services, mortgage finance and technology sectors.