Is it Homecoming Yet for Undistributed Foreign Earnings?

March 31, 2016by Team IRIS CARBON0

The undistributed foreign income of US companies has recently come into sharp focus with both Republicans and Democrats united in the view that the existing deferral tax system needs a re-look. Currently, the income earned by the foreign subsidiary of a US company is generally not subject to US tax until it is repatriated back as a dividend. Considering the high corporate tax rate of 35%, US companies would not want to bring back the offshore profits unless it is economically viable.

This time we take up the topic of Undistributed Foreign Earnings and attempt to identify companies that may consider repatriation under the current deferral tax system. This is the third in a series of recent articles we have written analyzing US companies.

To read an analysis of the US Banking sector amidst falling oil prices, read A Tale of Plunging Oil Prices and Swelling Credit Provisions

We also covered the fall of US Shale Oil Companies due to crude prices here: It’s a Crude Shock for Shale Companies

Reasons for huge undistributed earnings lying offshore

While looking at undistributed earnings lying offshore, IRIS covered large US companies with $50 billion or more of Total Revenues and $2 billion or more of undistributed foreign earnings for FY 2015 (The list excludes banking companies. For a 3-year trend for major banks, click on Link 1). The undistributed foreign earnings of these companies totals $764 billion which is 40% of the aggregate FY 2015 revenue of these companies.

There are 2 important reasons why companies choose to keep undistributed foreign income:
a) Higher Profit Margins: The net profit margin on overseas sales is greater than the margins in the US
b) Lower Tax Rates: Tax rates overseas are significantly lower than the US corporate tax rate of 35%

If a US multinational company pays significantly lower taxes in the country where it operates and if the net profit margin on foreign sales is more profitable than sales in the US, they are unlikely to repatriate funds back to the US. They would, instead, prefer to reinvest in the country they are operating in.

The study based on the twin criteria of net profit margin and tax rates outside of the US attempts to analyze whether it makes economic sense for these US companies to repatriate foreign earnings back to the US.

Table 1 below shows the 3-year data on undistributed foreign income and revenues for the 14 companies in our study. The data were extracted using our data platform, DCP

Table 1

*Undistributed Foreign Earnings on which deferred tax liability is not provided

A. Effect of Net Profit Margin on Repatriation of Undisclosed Foreign Earnings by Companies:
We drilled down further to see the revenue streams from US and non-US operations to understand the contribution of non-US revenue to the total income of these companies. Below are the findings:

a. Companies with higher profit margins on non-US Sales:

The chart shows companies whose net profit margin on non-US sales is greater than that of US sales for FY 2015.

Bar Chart 1

**Computed the percentage from amounts disclosed in 10-Ks if the percentage was not directly disclosed

Figure 1: Companies with higher profit margins on non-US Sales

For years Pfizer has been showing losses in its US operations presumably attributing major costs to US accounts. The profits come from its various foreign subsidiaries and hence the disproportionate share of foreign income in total income. In the case of Exxon Mobil, the non-US sales are 64% of its total sales whereas the contribution of foreign income is 99% of its total income. Looking at the scenario, it can be assumed that the companies shown above are less likely to repatriate funds back to the US since their foreign operations are much more profitable than their US operations.

b. Companies with In-Line or Lower Profit Margins on non-US Sales
On the other hand, there are a few companies, where foreign income as a percentage of total income is either in line with or below the share of their non-US sales to total sales. These companies are more likely to repatriate their foreign earnings back to the US if the need arises.

Bar Chart 2

**Computed the percentage from amounts disclosed in 10-Ks if the percentage was not directly disclosed

Figure 2: Companies with in-line or lower profit margins on non-US Sales
For 3 year trend in non-US Sales % and Foreign Income %, click on Link 2

The study found that while companies such as Alphabet, Apple, and IBM are generating income from non-US sales mostly in line with their US sales, companies such as Intel, Walt Disney Walmart, and Valero have a lower percentage of foreign income in total income even though the share of non-US sales in total sales is much higher. For example, Walt Disney generates 23% of its revenues from outside the US. However, the foreign income from these sales is just 7.5% of total income. Other things being constant, these companies have less to lose by repatriating earnings back to the US.

B. Effect of Tax Rates on Repatriation of Undisclosed Foreign Earnings by Companies:

In Table 2, we show the impact of foreign tax rates on foreign earnings for the large US companies in our study. For almost all companies, the tax rate on foreign earnings is substantially lower compared to the US statutory tax rate of 35%. In FY 2015, for IBM, the effective tax rate paid on foreign earnings is 17% below the US statutory tax rate of 35%. For Exxon Mobil, which operates in high tax rate countries, the effective tax rate paid on their foreign earnings is 6.44% higher than the US statutory tax rate of 35%.

Table 2

**Computed the percentage from amounts disclosed in 10Ks if the percentage was not directly disclosed
*** For GE, the foreign tax rate is very high because of the implementation of the GE Capital Exit Plan. The write off of deferred tax assets largely relates to treasury operations in Ireland where the tax benefits will no longer be apparent
****Statutory income tax rates applicable to the foreign countries in which Valero Energy Corp operates Link 3.
For 3 year trend in the overall effective tax rate, click on Link 4.

In the FY 2017 budget, President Obama proposes
1. Cutting corporate tax rate to 28%
2. Imposing a minimum tax of 19%, less than 85% of per-country foreign effective tax rate
3. Imposing a one-time tax of 14% on earnings accumulated outside the US and which have not been previously subject to tax

These tax proposals, if passed, could replace the current system of deferral of foreign earnings. Many companies with in-line or lower profit margins on non-US sales may then repatriate their foreign earnings back to the US.

For a few years now, two companies on that list (Apple and HP) have already been providing deferred tax liabilities on their undistributed foreign earnings. Interestingly, Pfizer has been providing for deferred tax liabilities on its undistributed foreign income. Is this a sign that Pfizer may repatriate its foreign earnings back to the US sometime in the coming years?

For a Free Demo of the IRIS CARBON® Solution.

Leave a Reply

Your email address will not be published. Required fields are marked *