Foreign Tax Surprise Like Disney’s Have SEC Seeking Sunlight

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Mickey Mouse
Mickey Mouse signs an autograph at Walt Disney Co.'s Disneyland Park, part of the Disneyland Resort, in Anaheim, California. In 2013, Disney nearly tripled to $1.5 billion the amount of foreign earnings exempt from U.S. taxes from a year earlier. Photographer: Patrick Fallon/Bloomberg

U.S. officials are concerned that the trillions of dollars companies park overseas are doing more than just helping them skirt taxes. They’re worried the practice leaves investors in the dark.

When Walt Disney Co. investors were trying to anticipate the company’s performance in late 2012, the company told them to expect taxes to take a bigger bite out of earnings than the previous year.

Then, the company reclassified some foreign income as exempt from U.S. taxes, transforming an expected cost into a windfall. The move added $64 million to Disney’s bottom line, representing almost 5 percent of net income for the quarter.

Disney made the change without explaining why. U.S. Securities and Exchange Commission officials pressed Disney for more information. Officials have done the same with several other companies since and now say there is growing concern that large multinational companies offer too little information about foreign taxes. Neither Disney nor any of the dozens of other companies that received queries about these issues from the SEC have been accused of wrongdoing.

“We are committed to providing clear and useful financial information to our investors and have provided disclosure designed to help them better understand the tax rate impact of our foreign earnings and investments,” David Jefferson, a Disney spokesman, said in an e-mail. He said the company has significant cash needs abroad but doesn’t have large cash balances “trapped” overseas.

Foreign Sales

Nevertheless, international tax payments have drawn greater scrutiny in recent years as U.S. companies have come to rely more heavily on foreign sales and complex strategies that allow them to reduce taxable income at home. More than 300 U.S. companies now hold about $2.1 trillion in profits overseas, according to data compiled by Bloomberg News.

The SEC, which doesn’t police tax payments, is now expanding a review aimed at pushing companies to say more about big overseas tax fluctuations that it says make it difficult for investors to predict earnings. Agency officials began the effort at a December conference by warning corporate accountants to be more forthcoming.

“There is very little transparency in tax,” said Tim Nollen, an analyst at Macquarie Capital USA who covers Disney. “It happens to be one of the most opaque areas of accounting.”

The focus on foreign taxes opens a new front in the SEC’s campaign to get public companies to explain the impact of their growing reliance on overseas earnings. The SEC previously pressured companies such as Apple Inc. and Google Inc. to disclose how much cash they kept overseas.

Tax Rate

The SEC’s inquiry doesn’t focus on how much a multinational actually pays in U.S. taxes, and indeed, Disney’s effective tax rate is usually close to the 35 percent federal rate. Rather, the push is aimed at how companies explain their tax numbers to investors. Last year, more than three dozen firms, including Anheuser-Busch InBev NV, General Electric Co. and Diebold Inc., received letters from the SEC seeking more information about how they reported foreign taxes.

None of these companies have been accused of wrongdoing.

Now that the SEC has raised questions about disclosures it views as too generic, regulators say they expect more fulsome details on tax payments in company reports.

The agency says many multinationals don’t adequately describe big shifts in tax payments, leaving investors ill-equipped to forecast earnings. Many of the companies operate in dozens of countries, yet typically report a single, consolidated overseas tax figure in their public filings. That makes it difficult to predict how political developments and changing business conditions in specific countries could affect profits.

`Not Sufficient'

“The reasons these disclosures are not sufficient and certainly cannot be called transparent is that many of the items included in that foreign tax line are subject to different trends and uncertainties,” Nili Shah, a deputy chief accountant in the SEC’s Corporation Finance division, which is responsible for examining company filings, said at an accounting conference in December. Shah didn’t cite any particular company in her speech.

The same goes for specific jurisdictions that are the focus of law enforcement. Few U.S. companies break out earnings routed through Luxembourg, Belgium, or the Netherlands. Yet all three countries are under investigation by the European Union, which could deem that tax deals with multinationals -- including Inc., Starbucks Corp. and Disney -- violate the bloc’s state-aid rules.

The issue has flared up as companies have become more reliant on overseas sales. Firms in the Standard and Poor’s 500 Index earned 39 percent of their sales outside the U.S. in 2013, up from 33 percent in 2006, according to data compiled by Bloomberg.

Apple to GE

At the same time, companies including Apple, General Electric Co. and Pfizer Inc. stockpiled about $2.1 trillion in offshore profits, claiming U.S. corporate taxes were too onerous.

President Barack Obama tried to address the issue on Feb. 2 in his proposed budget. He asked for a 14 percent one-time tax on the money parked overseas and a 19 percent minimum tax on future foreign earnings. He also has criticized companies that have escaped higher U.S. tax rates by merging with a foreign firm, a practice known as inversion that allows them to reincorporate overseas.

Even as the spotlight on foreign earnings has been brighter, companies’ disclosures have basically remained the same, said Gary McGill, an accounting professor at the University of Florida’s Warrington College of Business Administration.

“The world has changed and there is a lot more information that would be useful” to investors, McGill said.

McGill Paper

Under current accounting rules, permanently reinvested earnings can be easily manipulated, according to a 2012 paper by McGill and professors Michael Donohoe and Edmund Outslay. A 2004 paper by University of Oregon professor Linda Krull found evidence of firms that had missed earnings targets tweaking overseas income to make up shortfalls in future periods. Companies appear to continue to massage taxes in order to meet earnings targets, she said.

Aside from country-level detail, the SEC is also asking companies to explain decisions to change the amount of foreign-income that gets “permanently reinvested overseas,” a designation that typically shields the money from U.S. taxes. Those moves can cause big shifts in tax liabilities, creating a surprise for investors who were expecting a stable tax rate.

Theme Parks

In 2013, Disney nearly tripled to $1.5 billion the amount of foreign earnings exempt from U.S. taxes from a year earlier. Part of that was revenue from 2012. The move cut the company’s effective tax rate for 2013 by 1.9 percentage points.

In a Feb. 2014 letter to Disney, the SEC questioned why the company had reclassified earnings from an earlier year and why the overall tax rate had declined even though the company had earned less money in lower-tax countries.

In its reply, Disney said it made the moves because it needed more money for its media business, theme parks and resorts outside of the U.S. The company also said the decision to reclassify earnings from a prior year was appropriate under accounting rules. The regulator hasn’t sought additional answers from the company.

The media company announced a similar move Feb.3, when it again raised the amount of income it holds abroad. The move helped to lower its tax rate for the fiscal first quarter of 2015 to 33.3 percent from 35.2 percent a year earlier. Once again, Disney didn’t explain to investors why it made the move.

Benefit Offset

Nollen, the analyst, said he didn’t question Disney’s tax reversal because analysts often focus on adjusted earnings figures that omit one-time gains and losses, such as tax benefits. Disney’s 2013 fourth-quarter gain from its tax move was offset by restructuring charges that ate into net income, he noted.

“There are so many variations, and they can be positive or negative,” Nollen said. “Over time, they usually level one another out. So, we don’t worry about it perhaps as much as we could or we should.”

The SEC push to get companies to disclose more detail about unusual tax changes that significantly affect profit or loss will take shape as firms file their 2014 annual reports over the next few months. While no cases have been referred to the enforcement division, the SEC staff’s is already looking into what tools they have to push the companies to be more forthcoming. For one, the Public Company Accounting Oversight Board, which is overseen by the SEC, said it will lean on auditors to pay greater attention to the issue.

Low-Tax Countries

The SEC has had some success. After sending a comment letter to Skechers USA Inc. asking it to disclose pre-tax income attributed to low-tax countries, the company revealed that it routes the largest part of its foreign earnings through the Island of Jersey, which charges no corporate income tax.

In May, the SEC asked GE to break out tax effects from foreign countries that lowered the overall rate by at least 3 percent. GE, which operates in more than 170 countries, attributed the drop to lower tax rates in certain countries. It didn’t name the countries and said no single location had that much impact on lowering its overall tax rate for 2013.

In a statement, GE said it regularly provides “detailed country-level records” that help regulators evaluate the company.

AB-InBev, Starbucks and Apple declined to comment. Mike Jacobsen, a Diebold spokesman, said the company “responds fully to inquiries received from our regulators, including the SEC, and did so in response to this request.” Joan Campion, a Pfizer spokeswoman, said Pfizer makes the required disclosures for foreign income and taxes.

When a company rebuffs the SEC’s requests, the agency’s only recourses are to send another letter requesting the information, or to refer the matter to its enforcement attorneys. To prove a company is withholding important information, the SEC would need to seek records from other countries, which aren’t always eager to help.

“The SEC doesn’t have an army of tax accountants that could do this on a massive scale,” said Jason Flemmons, managing director at FTI Consulting Inc. in Washington, and a former deputy chief accountant of the SEC’s enforcement division. “If they could narrow it down to a couple of companies, it would be manageable and a good thing for them to start on.”

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