Minnesota companies shelter billions in cash from U.S. taxes

WASHINGTON — They are all companies that call Minnesota home: Medtronic, 3M, St. Jude Medical, General Mills and Ecolab. But they also all hold 90 percent or more of their cash outside the United States.

Amid a growing national political debate over corporate tax avoidance, some of the Twin Cities' biggest corporate citizens are accumulating giant stockpiles of money beyond America's borders and, therefore, beyond the reach of the Internal Revenue Service.

Hoarding foreign cash has become an increasingly popular — and completely legal — shelter for many of the country's major corporations as they lobby for reforms that will lower their tax bills. But the strategy keeps billions of dollars on the sidelines that could otherwise go toward U.S. capital investments, jobs, and research and development. It also reduces federal revenue by billions of dollars.

"It is a disaster for the U.S. economy," said Samuel Thompson, a Penn State law professor whose research includes corporate taxes. "If you decrease investment, you decrease the rate of growth and employment in the U.S."

The strategy is relatively new. Barely a decade ago, Medtronic held half of its cash in the United States. As recently as 2009, 3M held more than half of its cash domestically.

But in recent years companies have adopted strategies to expose as little of their profit as possible to a U.S. tax rate that is the highest in the developed world, at 35 percent.

A spokesman for Ecolab, a maker of cleaning and sanitizing chemicals and oil industry additives, said his company and others are simply responding to incentives the government has created.

"The U.S. tax system … encourages companies to keep cash overseas to avoid this additional layer of U.S. tax," spokesman Roman Blahoski said in an e-mail.

Many companies and their trade groups are pushing Congress to change the tax laws, or at least declare a tax holiday like one in 2004 that temporarily cut the tax rate on foreign profits.

At that time, U.S. companies brought back $312 billion at a U.S. tax rate of just 5.25 percent, a small fraction of what they otherwise would have owed. This was supposed to be a one-time deal, but some saw a precedent.

"It's a game of chicken," said Harvard Law School professor Stephen Shay, an authority on corporations' tax avoidance. "They're just waiting to have Congress give them a tax break."

Some companies don't want to wait.

University of Southern California law professor Edward Kleinbard, a former chief of Congress' Joint Committee on Taxation, says hoarded foreign profits are driving corporate America's recent push for so-called inversions. In such deals, companies move their legal residences to low-tax foreign countries while keeping most operations in the United States.

A record 10 companies have moved in the past year to reincorporate in foreign countries with lower tax rates, and one of the biggest such deals is Medtronic's attempt to buy Dublin-based Covidien for $43 billion. Medtronic says the deal will strengthen it strategically, but it also offers significant tax benefits.

The "surge in interest in inversion transactions" is fueled "by U.S.-based multinational firms' increasingly desperate efforts to find a use for their stockpiles of offshore cash," Kleinbard wrote for the online publication Tax Notes.

In an interview, Kleinbard said corporations have been stashing foreign profits for years while "strong-arming Congress" to eliminate or substantially reduce U.S. taxes on the money.

Major U.S. companies have accumulated more than $2 trillion in tax-deferred foreign profits, according to Citizens for Tax Justice, a research group that advocates for closing loopholes. The amount grew by $454 billion from 2010 to 2013.

Some of those profits have been reinvested in foreign capital equipment and factories. But a 2012 analysis by investment bank J.P. Morgan estimated that 60 percent of tax-deferred foreign profits — over $1 trillion — was held in cash.

There's a good reason companies do this. It saves them a lot of money. The U.S. Government Accountability Office reported that in 2010 the average effective corporate tax rate for U.S. companies — the percentage of profits they actually paid in tax — was 12.6 percent. One of the principal strategies that gets them to that number is to "indefinitely" defer U.S. taxes on foreign profits.

American corporations now pay foreign taxes to the countries where they earn profits. If they distribute those profits in the U.S., they are also supposed to pay the U.S. government the difference between what they pay foreign governments and what they would have paid in U.S. taxes had the income been earned here.

To avoid an IRS bill, foreign cash can be put into standard commercial bank accounts, explained University of Michigan economist James R. Hines Jr. It can also be used to buy U.S. Treasury bonds or for very short-term loans and trade credits, he said.

But until they pay U.S. taxes, companies can't use foreign profits to fund dividends, stock buybacks, executive bonuses, U.S. capital projects and most debt repayments or research and development.

Collectively, cash accumulated in foreign subsidiaries costs the debt-ridden U.S. budget an estimated $50 billion to $60 billion per year, according to the Congressional Joint Committee on Taxation.

Of course, some cash stays overseas because companies see good opportunities to reinvest profits in growing markets.

Blahoski said Ecolab has invested more than 80 percent of its foreign profits outside the U.S. An example would be a production facility in Singapore. Ecolab holds a "much smaller amount of cash — approximately $300 million" offshore, Blahoski said.

Minnesota-based Cargill Inc., one of the world's largest private companies, says roughly 60 percent of its revenue comes from outside the U.S. Based on reported net earnings of $2.31 billion in 2013, foreign income for that year would account for nearly $1.4 billion of that total.

Cargill, which is not required to publicly disclose many financial details, declined to say how much it holds in tax-deferred foreign profits and how much of that amount is cash.

"We generally reinvest our foreign earnings to support our growth abroad," spokesman Tim Loesch said in an e-mail. "For example, we build grain elevators and food processing plants … U.S. tax on such earnings is deferred. However, foreign tax is not. We pay substantial foreign income taxes."

Some maneuvers, however, are much less straightforward.

As an example, said Penn State's Thompson, an American corporation may incorporate its intellectual property in a company in the Cayman Islands, which has no corporate income tax. The Caymans company may be no more than a storefront or a post office box. But the American corporation can then lease the intellectual property back from its Caymans subsidiary. The lease payments become deductions that eat up all or most of the U.S. corporate tax liability for profits earned on the intellectual property.

Citizens for Tax Justice and the Public Interest Research Group, which both advocate for a progressive tax code, say hundreds of America's biggest corporations operate subsidiaries in countries identified by the Government Accountability Office as tax havens. Their list has 15 Minnesota companies, including Ecolab, General Mills and Medtronic.

Companies that responded to a Star Tribune request for comment said they pay taxes where they earn profits and do not consider the locations of foreign subsidiaries to be tax havens.

Still, a backlash is building against some corporate tactics.

Amid the proliferation of inversion deals, the Treasury Department recently announced new rules that will no longer let corporations avoid U.S. taxes by using internal loans. That was part of Medtronic's original plan for the Covidien deal.

In a Sept. 8 speech, Treasury Secretary Jacob Lew said corporations have been able to "avoid their civic responsibilities while continuing to benefit from everything that makes America the best place in the world to do business … This may be legal, but it is wrong."

Medtronic could have avoided $3.5 billion to $4.2 billion in U.S. taxes by loaning its $14 billion in foreign cash to itself in the Covidien deal, but turned to outside lenders in response to the new Treasury rules. The company has argued that reincorporating outside the U.S. will make it easier to invest in U.S. operations in the future.

"We are challenged by our inability to use [foreign] cash in the U.S., which greatly affects our flexibility to invest in areas that are critical to our business — a challenge not faced by non-U.S. companies," spokesman Fernando Vivanco said in an e-mail.

Many companies and some elected officials see a need to more dramatically overhaul the corporate tax system.

Finance committee proposals in the U.S. Senate and House anticipate lowering the statutory corporate tax rate of 35 percent. Both proposals also anticipate doing away with some loopholes.

Another possibility would be a "territorial tax system" that allows companies to pay taxes only in the country where profits are earned.

"Nearly every other country can bring back their profits without paying a penalty," said Republican Rep. Erik Paulsen, whose district includes many of Minnesota's biggest companies. "We should be making the United States the best place to do business."

Rep. Keith Ellison, a Democrat who represents Minneapolis, says his corporate constituents are pushing to lower the corporate tax rate and let businesses significantly reduce their U.S. tax bills on foreign profits. Ellison thinks Congress should end tax deferral on currently stashed profits as a starting point for reform.

Deferral "doesn't help the economy," Ellison said. And it doesn't make sense when the country is "struggling to pay for programs like Head Start and food stamps."