Discussion:
During the most recent presidential election there was a lot of debate about U.S. companies not repatriating earnings back to the U.S. Many companies have no intention of ever bringing those earnings home under the current tax rules.
Do you feel that companies overstate their tax expense if they never intend to bring those earnings home (and thus pay U.S. tax on them)? If so, what is the consequences to investors if the expense is overstated and therefore earnings understated?
Respond to two students:
Student 1(Irwin):
Many companies will not intend to bring their earnings back into the United States and will look for ways to overstate any tax expense to avoid repatriating profits. Most of them participate in such practices because they see that tax rates for corporations in the U.S. are too high, being 35%, therefore seeing it as unfair.
This practice consists of companies in the U.S. setting the profits earned abroad and parking them in those countries to take advantage of any tax loopholes.
There are consequences to this course of action since this will mean that companies will not be able to present as much net income, which will affect other factors. Decreasing the net income will make chances of getting a good dividend payout less possible.
Due to lowered net income, EPS (earnings per share) will also be negatively affected by these changes. All this will reflect poorly on the company’s reports, leading investors to question the value of equity that the company can contribute.
Student 2(Hannah):
When a company does not repatriate earnings, they don’t bring accumulated earnings from other countries back to the U.S. to avoid taxes. The explanation for this is usually the tax on repatriation and many companies believe the tax rate is too high.
Without repatriating earnings, a company must overstate the tax expense or not report the income from other countries. Both of these courses of action will lead to a decrease in net income.
When earnings are understated, investors make less profit on their investment in the company. This can make investors weary of continuing to support the company and dissuade new investors from investing in the company.