Why Don't Multinationals Bring More Profits Home?

Why don't U.S. companies bring more overseas profits home? Accounting rules are partly to blame.
Senator Carl Levin of Michigan gets it. Photographer: Drew Angerer/Bloomberg

The big surprise from eBay Inc. this week is that it's taking a $3 billion charge to earnings after deciding that it might repatriate $9 billion in profits held by foreign subsidiaries. So why don't more U.S. companies bring home more of their profits?

The usual reasons cited are that U.S. tax laws are too convoluted and the 35 percent marginal corporate tax rate is too high. And that may be true. Yet there's another big disincentive that usually doesn't get much attention: U.S. accounting rules.

This was a major focal point of a 2012 Senate Permanent Subcommittee on Investigations hearing on offshore profit-shifting and the U.S. tax code. The panel focused mainly on Microsoft Corp. and Hewlett-Packard Co. as examples. It also spotlighted a longstanding accounting rule called APB 23, which covers how U.S. multinationals should account for taxes they will have to pay when they repatriate overseas profits. (APB stands for Accounting Principles Board, which was a predecessor to the Financial Accounting Standards Board.)

Senator Carl Levin, the Michigan Democrat who chairs the panel, gave one of the best, most succinct explanations of the problem that I've seen. Here's how he described it in his opening statement:

Under APB 23, when corporations hold profits offshore, they are required to account on their financial statements for the future tax bill they would face if they repatriate those funds. Doing so would result in a big hit to earnings. But companies can avoid this requirement and claim an exemption if they assert that the offshore earnings are permanently or indefinitely reinvested offshore. Multinationals routinely make such an assertion to investors and the Securities and Exchange Commission on their financial reports.

And yet, many multinationals have at the same time launched a massive lobbying effort, promising to bring these billions of offshore dollars back to the United States if they are granted a "repatriation holiday," a large tax break for bringing offshore funds to the United States. On the one hand, these companies assert they intend to indefinitely or permanently invest this money offshore. Yet they promise, on the other hand, to bring it home as soon as Congress grants them a tax holiday. That's not any definition of "permanent" that I understand.

While this may seem like an obscure matter, it is a major issue for U.S. multinational corporations. A 2010 survey of nearly 600 tax executives reported that "60 percent of the respondents indicate that they would consider bringing more cash back to the U.S. even if it meant incurring the U.S. cash taxes upon repatriation, if their company had to record financial accounting tax expense on those earnings regardless of whether they repatriate."

In 2011, more than 1,000 U.S. multinationals claimed this exemption in their SEC filings, reporting more than $1.5 trillion in money that they say is or is intended to be reinvested offshore.

So if a U.S. multinational wants to show lower tax expenses and higher earnings for accounting purposes, all it has to do is label foreign profits as indefinitely or permanently invested overseas. And wham, it's done. The company can change its mind later. Levin's point was that more companies would be inclined to bring home their profits sooner if they already had been required to show the tax expense for accounting purposes on their financial statements.

It's worth noting, too, that eBay says it hasn't decided whether to actually repatriate the profits. It merely changed the classification under generally accepted accounting principles to reflect that it might, which triggered the charge to earnings. In an interview with Bloomberg News, eBay Chief Executive Officer John Donahoe said: "We haven't committed to repatriate any of the cash, so we'll make that decision as we go along." He said eBay may use the money for potential acquisitions, but that no big domestic deal is in the works.

There is nothing new, of course, about companies' economic decision-making being directed by accounting considerations. One of my favorite illustrations of this was a 2002 study led by University of Chicago accounting professor Merle Erickson called, "How Much Will Firms Pay for Earnings That Do Not Exist?" He and two other professors looked at 27 companies that the SEC had accused of accounting fraud and found they had paid $320 million in taxes on overstated earnings of about $3.4 billion.

In other words, the companies overpaid their taxes to help maintain the illusion that their earnings were real. Better yet, after they eventually restated their earnings, some companies got refunds for the taxes they had overpaid.

By comparison, labeling profits as permanently reinvested overseas is kid stuff. Outsiders aren't in a position to challenge the label's accuracy. The companies get to make their earnings look better, resulting in all sorts of wonderful prizes such as bigger bonuses for the executives who do the labeling. Accounting is supposed to reflect behavior, but often it's also the driver.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.