This Insights article was contributed by Zhan Furner, Ph.D., assistant professor of accounting.
In August, the European Competition Commission determined that Ireland had given Apple’s Irish subsidiaries illegal tax benefits, and it calculated that these subsidiaries owe Ireland nearly $14.5 billion in back taxes.
The size of this ruling has reignited the debate in here in the United States about tax policies that permit U.S.-based multinational corporations (MNCs) to accumulate their foreign earnings overseas without paying U.S. taxes.
Apple is not alone.
According to the Citizens for Tax Justice’s March 2016 estimate, MNCs in America held over $2.4 trillion in foreign earnings abroad for the sake of avoiding U.S. taxes, which if repatriated, could represent $695 billion in potential tax revenue. For reference - the U.S. budget deficit for fiscal year 2016-17 is $590 billion.
The American tax system is widely blamed for creating incentives for U.S. firms to hold foreign subsidiaries' profits in low-tax countries, to the detriment of domestic investment and employment opportunities. Under the U.S. worldwide tax system, American-based MNCs pay taxes on their global incomes without including foreign subsidiaries in their U.S. consolidated tax returns. Earnings generated by foreign subsidiaries are taxed in the U.S. only when those earnings are repatriated (i.e. returned to the United States).
On the other side, current U.S. financial reporting standards also strongly encourage MNCs to keep their foreign earnings abroad. Under GAAP, U.S. MNCs are exempted from accruing tax liabilities on undistributed foreign earnings for financial reporting purposes if those earnings are designated to be reinvested overseas permanently.
The advantages of not recognizing tax on permanently reinvested earnings (PRE) are critical for U.S. MNCs because they can therefore enjoy a lower GAAP effective tax rate, which results in higher accounting performance measures (i.e. after-tax profits), thus affecting stock prices, shareholder returns and executive compensation contracts, such as stock options and bonuses.
Although MNCs are required to disclose the amount of PRE on their financial statements, the disclosure requirement affords managers a great deal of discretion in terms of the amount of PRE to report, as well as the timing of the designation. And the consequences of having incomplete or inaccurate disclosure are negligible.
Prior research suggests that MNCs use the PRE designation as a way to manage earnings – or make earnings appear better to investors - by taking advantage of the PRE loophole and the subjectivity in the interpretation of the disclosure requirements.
Dr. Furner’s research demonstrates that:
Robert T. Burrus, Jr., Ph.D., is the dean of the Cameron School of Business at the University of North Carolina Wilmington, named in June 2015. Burrus joined the UNCW faculty in 1998. Prior to his current position, Burrus was interim dean, associate dean of undergraduate studies and the chair of the department of economics and finance. Burrus earned a Ph.D. and a master’s degree in economics from the University of Virginia and a bachelor’s degree in mathematical economics from Wake Forest University. The Cameron School of Business has approximately 60 full-time faculty members and 20 administrative and staff members. The AACSB-accredited business school currently enrolls approximately 2,000 undergraduate students in three degree programs and 200 graduate students in four degree programs. The school also houses the prestigious Cameron Executive Network, a group of more than 200 retired and practicing executives that provide one-on-one mentoring for Cameron students. To learn more about the Cameron School of Business, please visit http://csb.uncw.edu/. Questions and comments can be sent to [email protected].
Morgan Milne said he’s dedicated to providing quality produce for the community to enjoy, and his farm, Red Beard Farms, is already making s...
While North Carolinians living in urban areas are speeding forward on the information highway, many of their rural neighbors – some 226,000...
Brett Lanier, president of Isosceles Pharmaceuticals, shares his top tech and info picks....