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By John Goff
Looks like the honeymoon is over.
President Barack Obama yesterday unveiled a tax overhaul that's likely to agitate one of his most ardent group of supporters: technology executives.
As expected, the President announced a plan to clamp down on tax loopholes that that have greatly boosted U.S. businesses with global operations. Specifically, the President and Treasury Secretary Timothy Geithner revealed their proposal to revamp both the deferred tax allowance and the "check-the-box" provision for foreign subsidiaries of U.S. corporations.
The tax deferral rule enables businesses to indefinitely postpone paying taxes on profits generated by cross-border operations—even though the companies are allowed to deduct the expenses from those operations. The check-the-box provision was initially intended to ease the reporting burdens of U.S. companies with scores of global subsidiaries. But critics, including the new administration, claim the provision has allowed businesses to hide revenues generated by foreign subsidiaries.
Corporate trade groups see it differently. They argue that the tax breaks help overseas subsidiaries of U.S. businesses compete with foreign competitors, which typically pay a lower rate in their home markets. Not surprisingly, many tech companies never repatriate profits generated abroad, choosing instead to plow the money back into their cross-border operations. It's an effective tax strategy. In 2004, U.S. companies as a whole paid $16 billion of taxes on $700 billion of foreign earnings. That works out to a paltry 2% tax rate.
In announcing his controversial plan yesterday, President Obama said he was trying to bring fairness and balance to "a tax code full of corporate loopholes." But corporate executives—including many in the tech sector—will be hell-bent on preserving those loopholes. Indeed, Kenneth Kies, a tax lobbyist at the influential Federal Policy Group, which counts General Electric and Microsoft as clients, told Bloomberg: "This is going to be the biggest fight for the corporate community in the next two years."
That's understandable. Without the tax deferral loophole, scores of marquee IT companies will surely take a sizeable hit to after-tax earnings. Cisco, for example, now generates more than half of its sales outside the U.S., and the networking giant relies on tax deferral to shelter some of that income. Cisco, which recorded nearly $40 billion in revenue in 2008, apparently lowered its effective tax rate by 16.1 percentage points through tax deferral.
Yesterday, the company's management issued an ominous statement. "If rules are changed on tax deferral and we are taxed in the U.S. on non-U.S. profit, this significant additional U.S. tax cost would adversely impact our ability to invest and grow our business in the U.S... and to compete against our foreign competitors who are not subject to this U.S tax."
In March, executives at a number of technology companies and other multinational businesses launched a preemptive strike, sending a letter urging Congressional leaders to leave the deferral provision alone. Oracle, Microsoft and GE were among the 200 companies that signed the letter.
But President Obama, who campaigned on bringing American jobs back home, appears determined to revise a tax code that often rewards companies for shipping work overseas. "It's time to finally do something about these problems," he said yesterday. And Geithner noted that ending these "indefensible tax breaks and loopholes" will net Uncle Sam about $210 billion in additional tax revenues over the next decade. Right now, the Treasury can use all the cash it can get.
To cull corporate support for its controversial plan, the White House is also proposing to make permanent the ever-expiring research and development tax credit. But the prospect of gaining a permanent credit for R&D--a hot topic in IT Land for years—may be cold comfort to tech sector execs now.
In fact, Carl Guardino, CEO of the Silicon Valley Leadership Group, is reportedly leading a delegation of valley executives to Washington this week. The agenda? Among other things, the group apparently plans to talk to federal officials and congressional leaders about the administration's plan to close the tax deferral loophole—a proposal which is rattling boardrooms in Silicon Valley. "On a Richter scale of 1 to 10," Guardino told the Mercury News, "this is about a 20."
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