The Solution to the Tech Sector's $300 Billion Problem

American companies have hoarded foreign profits abroad for years, as bringing the cash back to the United States would subject it to the highest corporate tax rate in the industrialized world. Now, Ways and Means Committee Chairman Rep. Dave Camp (R-Mich.) has released his proposed tax reform, which would close loopholes, enact a repatriation tax holiday, and exempt from taxes 95% of foreign profits repatriated to the U.S. Read on to find out more on what the proposed tax reform means for U.S. companies -- particularly the tech sector -- and how you may profit.

The problem
The U.S. tax system creates incentives for companies to move their profits offshore and keep them there. This is because any profits brought back to the U.S. are then taxed at the U.S. rate. Companies can hold off on paying taxes on these profits by keeping them abroad, which is what many do.

Facing the highest corporate tax rate in the industrialized world, many U.S. companies go to great lengths not to pay it. Apple  (NASDAQ: AAPL  ) , Google  (NASDAQ: GOOGL  ) , Microsoft (NASDAQ: MSFT  ) , and countless others use loopholes and strategies with names like the "Double Irish" and the "Dutch Sandwich" to convert U.S. profits to foreign profits and thus pay minimal taxes on their earnings. While many people don't like this, as a recent Senate investigation of Apple and Microsoft found, it's perfectly legal.

This has led U.S. companies to hoard massive amounts of cash abroad. The top five are:

 

Company

Cash Held Abroad

1

Apple

$124.4 billion

2

Microsoft

$75.7 billion

3

Cisco (NASDAQ: CSCO  )

$43.8 billion

4

Google

$33.6 billion

5

Qualcomm (NASDAQ: QCOM  )

$22.9 billion

Source: Company financials as of Dec. 31, 2013.

These five tech companies are sitting on a combined $300 billion in cash abroad, while U.S. companies as a whole are sitting on nearly $1 trillion worth of foreign earnings. Companies have been waiting for Congress to announce a repatriation tax holiday or reform the tax system. Unexpectedly, Congress recently proposed both.

The Camp Plan
After three years of work, last week Rep. Camp put forward the proposed "Tax Reform Act of 2015," also known as the Camp Plan. The first major tax reform proposal in years, the bill proposes changes to the tax code for both individuals and companies. Here are the biggest ones under discussion:

  • U.S. corporations would get a new income tax rate of 25%, bringing the U.S down from its No. 1 spot in the industrialized world.
  • The U.S. would switch to a participation exemption system for the taxation of foreign income for corporations. Under this system, 95% of dividends paid to U.S. corporations by their foreign subsidiaries (which must own at least 10% of the foreign corporation) would be exempt from U.S. taxation.
  • To facilitate the switch to the new system, U.S. corporations would be allowed to repatriate pre-2015 profits at a special rate of 8.75% for cash, or 3.5% for earnings and profits that were reinvested in foreign operations.
  • The bill would also close the loopholes that allow big tech companies to convert U.S. profits to foreign profits by enacting neutral tax treatment of income attributable to intangible property, whether held in the U.S. or in a foreign country.

If the Camp Plan passes, it will allow U.S. companies to pay a fraction of the taxes on foreign profits that they would have paid if they had brought back the money before. It also removes the disincentive to bring profits back to the U.S. Overall, the Camp Plan is expected to result in an estimated 1.5% GDP boost to the economy over the next decade.

How you can profit
Shareholders in many companies -- in particular the big five tech companies mentioned above -- could be in for a treat in the form of buybacks or special dividends. I've written before about how a repatriation tax holiday could provide a major boost to the economy, why tech companies should pay large dividends, and how Apple in particular could use private equity's secret to make its shareholders a 100% return.

Bottom line
It's anybody's guess at this point whether the bill will pass and, if it does, what will change. But one thing is certain: In both the public and private sectors, governance functions best when stakeholders educate themselves, take an active interest in what's going on, and hold their representatives accountable. Educate yourself and tell your representative now what you think of the Camp Plan.

It works the same way with public companies. Educate yourself, take an active interest in the companies you own, and hold management accountable for how they allocate your cash.

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