US tax reform has prompted many companies to review their cash repatriation policies. But how and why does cash become ‘trapped’ in overseas markets, what are the benefits of bringing cash home – and when is it preferable to leave cash where it is?
Companies around the world are continuing to hold high levels of cash. Mark Smith, head of Global Liquidity for Global Transaction Services at Bank of America Merrill Lynch, comments that since the financial crisis, corporates have increasingly aimed to carry more cash on their balance sheets in order to build a more significant buffer against unforeseen circumstances. At the same time, low interest rates have prompted some companies to issue debt for large acquisitions, rather than make use of that cash. “In other words, there has been a build-up of cash from a defensive standpoint, and there hasn’t been any need to deploy that cash urgently because debt has been so cheap,” he says.
But while a cash buffer can provide a sense of security, in practice not all of the cash held by a multinational company may be readily accessible. From stringent foreign exchange controls to tax considerations, there are many factors which can make it difficult for treasurers to bring cash home from overseas offices.
For corporate treasurers, one perennial goal is to overcome these obstacles and reduce the amount of cash trapped in other markets. This is certainly the case for George Dessing, Senior Vice President, Treasury & Risk at global information, software, and services company Wolters Kluwer. “We want to provide value for stakeholders, which means that we want to limit the amount of trapped cash, or restricted cash as we refer to it, and therefore maximise the cash which is repatriated to the central parent level in the Netherlands,” he explains.
At the end of 2017, the company’s restricted cash amounted to around €17m, down from €29m in 2016. As Dessing comments, “Most of the restrictions we face are due to local exchange control regulation on exporting cash and capital out of the country – and we even mention that explicitly in the notes to our annual report, so it’s definitely a topic receiving a certain amount of attention in our financials.”
Where Wolters Kluwer is concerned, Dessing says that restrictions can be found in a number of markets, including countries where exchange controls are prevalent – such as China, India and Brazil – as well as other emerging markets and some Eastern European countries.
“China has always been a challenge in this landscape although the authorities have over recent years made a number of attempts to allow more movement, albeit sometimes for certain periods before reimposing restrictions,” comments Yera Hagopian, Head of Liquidity Services, Barclays Corporate Banking. “Certain Latin American countries such as Brazil, Argentina and Venezuela also present challenges alongside other Asian countries like India, Thailand, and South Korea.” She adds that Russia and Turkey “are still in the more challenging space when it comes to free movement of cash”.
“In this way, factors that should not normally lead to a trapped cash problem can contribute to the outcome.”
Yera Hagopian, Head of Liquidity Services, Barclays Corporate Banking
But tax and regulatory factors are not the only reasons why companies may have issues around trapped cash. “Poor visibility or inaccurate data can impede efficient cash management,” says Hagopian. “Zero balancing may need to be watered down to target balancing, with substantial local buffers if there is the risk of overdrawing the local account and incurring a hefty local overdraft charge. Similarly, organisational factors may have some bearing on how cash is managed.”
Hagopian points out that in organisations where payments are decentralised across different markets, local operations will require a degree of control over their cash flows, as well as the certainty that their payments have adequate access to funding on an intraday basis. “In this way, factors that should not normally lead to a trapped cash problem can contribute to the outcome.”
Weighing the risks
As Hagopian explains, there is a dilemma in that the markets which present the most challenging environments for cash repatriation “often present the greatest concern regarding country risk”. As such, she says that these considerations are best contemplated at the outset when investment in a particular market is being reviewed.
“The decision to invest may still be upheld, but the capital and funding structure of the local operation may be different as a result of a holistic review, given the reliance on dividends and royalties as the primary mechanism for repatriating cash. In addition, the attraction of a taxation rate for profits has to be weighed against the restrictions upon repatriation.”
Naturally, there’s no one size fits all when it comes to managing cash effectively. Where Wolters Kluwer is concerned, Dessing says that the group faces a variety of financial risks, including liquidity risk, market risk and credit risk, all of which are managed via a strict financial framework, policies and procedures. Against this backdrop, the company’s total debt is around €2bn – “and therefore you want to reduce that by having access to all available cash on a global basis.”
Dessing says that Wolters Kluwer tackles this task via a three-pronged approach. “First of all, we are using global cash pooling structures to gain access to cash, even in countries which have certain limitations,” he says. “Secondly, our intra-group financing includes certain netting and settlement structures that we use internally. And finally, we reduce the restricted cash via our internal dividend policy.”
Impact of the US tax reform
While the issue of trapped cash has long been a concern for treasurers, conditions in specific markets can and do change over time. One notable development in recent months has been the US tax reform: as well as cutting corporation tax from 35% to 21%, the reform set out to encourage US corporations to repatriate foreign earnings, offering a reduced one-off repatriation tax rate on profits brought back to the US.
The consequences of this development could be significant. “The United States Worldwide system meant around US$2.5trn of cash was parked abroad by some estimates, discouraging onshore investing, debt restructuring and dividend payments,” says Hagopian. “At 35%, the rate of US Federal Income Tax was considerably higher than the average across the OECD, resulting in a deemed lack of competitiveness for attracting and retaining business in the US.”
Consequently, Hagopian says that the reduced transition tax, reduction in income tax rate and the ruling that foreign subsidiary earnings and dividends from foreign subsidiaries will not be subject to US tax in future, “has led many US multinationals to reconsider their repatriation policies”.
Some companies have been quick to take advantage of the opportunity. Apple, for example, announced in January that it anticipated repatriation tax payments of approximately US$38bn – implying that the company planned to repatriate around US$245bn.
But there are other factors to consider. Hagopian notes that there is a new minimum tax on ‘global intangible low-taxed income’ (GILTI), while CFC rules still apply to certain ‘passive’ income, making it subject to full US tax rate. “Of course, foreign capital gains remain subject to US taxation and local withholding or dividend taxes may still apply in local markets,” she adds.
To repatriate or not to repatriate?
When it comes to taking advantage of the changes, not all companies are alike. Bank of America Merrill Lynch’s Smith points out that large companies in sectors such as pharmaceuticals and technology may have built up large cash balances which they may have placed in short-term investments – “and they were waiting for repatriation to happen so that they could bring that cash onshore.”
For other companies, however, the situation may be somewhat different. “A lot of overseas cash is actually needed to run the overseas operation, so not all cash is eligible for repatriation,” says Smith. “Another factor is that companies have put together structures for their overseas cash that are sometimes complex, but ultimately efficient – and that efficiency may still hold post-tax reform. In any case, these structures can be quite time consuming and sometimes costly to unwind.”
“In some cases, tax considerations outweigh the benefit of transferring cash in the long run. We sometimes leave the cash in-country, but mostly we try to get it to a central level.”
George Dessing, Senior Vice President, Treasury & Risk, Wolters Kluwer
Consequently, Smith says that the bank has not seen a significant volume of flows as a result of the US tax reform. While some larger companies have taken advantage of the opportunity, many others are taking time to weigh up their operating cash needs versus their excess cash. Another consideration is that in some cases, there may be attractive investment opportunities overseas, which may mean companies can earn more overseas than they can by repatriating that cash.
Of course, taking the decision to repatriate cash is not the end of the story. “Even once they have reached their conclusions and found that they have cash that is eligible and desirable to repatriate, they still have to go through a process to actually repatriate it,” says Smith. He notes that undertaking a capital distribution from a subsidiary to a parent can take time: “Cash could be buried several layers below that parent and you are going to need to do financial statements, have those audited and get tax advice. So there are practical reasons why it can take time to gather cash efficiently into the place where it is needed, and then execute the repatriation.”
Weighing the options
These considerations are not limited to the developments in the US. While there are many good reasons for repatriating cash, from reducing reliance on external funding to taking advantage of opportunities for higher yield, there may also be situations when companies choose to leave cash where it is.
“Apart from the non-discretionary reasons relating to local regulations, punitive tax consequences are a primary reason for leaving cash in local operations, even if it is not needed for operational purposes,” says Hagopian. She points out that withholding taxes generally apply to cross-border payments of interest, dividends and royalties. Likewise, transfer pricing considerations can apply to inter-company loans and deposits that require interest arrangements to be conducted at arm’s length to prevent potential tax avoidance.
“In some cases, tax considerations outweigh the benefit of transferring cash in the long run,” comments Dessing. “We sometimes leave the cash in-country, but mostly we try to get it to a central level.”
Another consideration is the need for treasurers to provide their relationship banks with revenue opportunities. “If deposit rates are attractive and risk is acceptable, a local deposit or investment product may be a good way of rewarding a relationship bank, especially if the cash cannot be put to better use elsewhere,” Hagopian explains. “Manufacturing and production sites can often be set up in challenging countries, and sometimes the best way to use cash is to invest further in that country to then generate more finished goods for sale. These goods can be destined for the home market, leading to bigger dividend repatriation if that is possible, or made available for export.”
The currency in which cash is denominated will also need to be taken into account. Hagopian notes that consolidation of minor currencies may not always make sense, “especially where there are no corresponding funding requirements and currency markets are not deep enough to be certain of a beneficial exchange rate for swaps, whether real or virtual by way of a multi-currency pool”. Likewise, in some Asian markets, it is possible to repatriate foreign currency but not local currency.
Keeping up to date
It’s clear that there are many factors to consider when it comes to a company’s cash repatriation policy – and given that market conditions and local regulations are not set in stone, treasurers need to be fully apprised of any developments which may affect their chosen approach.
Dessing explains that the company’s treasury stays on top of these questions by leveraging local knowledge not only from the tax department, but also from local units that can advise about in-country changes. “We also speak to certain trusted advisory firms, our global banking partners and local and international treasury peer groups,” he adds.
In conclusion, there is much to be gained by bringing cash home wherever this will benefit the company. But before this can happen, it is essential to have a full understanding of current market conditions, the mechanics of the repatriation process – and any factors which could mean cash could be put to better use in local markets.