The Fight to Bring Back Corporate Cash
When the founders of the United States framed the American Constitution, one of the concerns that guided their work was the knowledge that popular democracy would eventually become an entirely commercial proposition. This fear is clearly illustrated by the tax “reform” legislation just passed by the Republican majority in Congress. It seeks to buy votes next November with reductions in federal tax revenue that must ultimately be funded with ever larger amounts of public debt.
Of course, all of us hope that the various provisions of the tax bill will in fact lead to more investment, higher productivity and increased economic growth. Yet if we examine the narrative that helped to win passage of the legislation, many of the assertions made by politicians and their allies in the world of economics make little sense. In particular, the notion that lower corporate tax rates will lead to repatriation of corporate cash stashed offshore, thereby funding increased investment and productivity, and ultimately creating more jobs in the United States is, upon reflection, a complete nonsense.
First and foremost, corporate investment decisions are based upon the cost of capital and the prospective equity returns that new investment can generate, not the availability of cash. In a world where corporate bond yields are at all time lows and equity market valuations are at all-time highs, the effective cost of capital for many multinational companies is arguably negative. The problem is not funding new investments, but finding new endeavors in which to deploy cheap and plentiful capital.
The economists who largely control the major central banks in the industrialized nations may be able to manipulate markets and cancel excessive debt through open market operations, but they cannot manufacture attractive investments. Indeed, the low interest rate regime put in place by the Federal Reserve, the European Central Bank and the Bank of Japan arguably retards new productive investments by driving cash into real estate, commodities and speculative whimsies such as cryptocurrencies.
One of the most outrageous fallacies put forward by economists over the past year is that lower U.S. corporate tax rates will cause the repatriation of offshore cash balances. This view, which is widely endorsed by many analysts, fails to reflect the true nature of offshore tax schemes and how problematic it will be to reverse these complex transactions.
In 2016, Karen C. Burke and Grayson M.P. McCouch the University of Florida published an article entitled “Sham Partnerships and Equivocal Transactions” for the American Bar Association’s journal Tax Lawyer. The understated article provides an in-depth look at how American corporations have stashed literally trillions of dollars in offshore venues since the 1990s to avoid domestic taxes. The authors state:
“Corporate tax shelters proliferated during the 1990s, exploiting the flexible partnership tax rules of Subchapter K to defer or eliminate tax on hundreds of billions of dollars of corporate income. The corporate tax shelters were typically structured as a financing transaction in which a U.S. corporation leased its own assets back from a partnership, generating a stream of deductible business expenses while shifting taxable income to a tax-indifferent party such as a foreign bank. Since the transaction allowed the U.S. corporation to raise capital in a tax-advantaged manner in connection with its regular business operations, it was assumed that the transaction had economic substance. Nevertheless, in scrutinizing these shelters, courts have invoked a sham partnership doctrine, derived from the longstanding Culbertson intent test, which disregards a partnership that lacks a bona fide purpose (or, alternatively, a purported partner whose interest does not constitute a bona fide equity participation).”
The Internal Revenue Service (IRS) is on to these fraudulent scams for which, of note, there is no statute of limitations. Significantly, in January of 2017, the U.S. Supreme Court declined to hear an appeal involving an adverse tax decision by the IRS against an affiliate of Dow Chemical known as Chemtech. The hundreds of corporations that have used offshore transactions to hide revenue knew that Dow’s appeal was their last hope to avoid sanctions by the IRS. General Electric is another example of an American corporation that has been forced by the IRS to reverse a bogus offshore “asset sale” transaction.
The IRS process of disallowing sham offshore transactions can be catastrophic. Consider the 2012 bankruptcy of tanker operator Overseas Shipholding Group (OSG). When the IRS disallowed half a billion dollars in offshore “asset sale” transactions, the company was forced to file bankruptcy and restate years of financial statements. A torrent of litigation ensued.