Another repatriation wave into the USD? - Westpac

The US presidential election has given fresh impetus to another repatriation tax holiday for US corporate earnings held offshore notes Research Team at Westpac and they expect that the US equities and the USD will be the main beneficiaries, mostly in 2018.

Key Quotes

“The incoming Trump administration, aided by a Republican-controlled Congress, is set to pursue broadbased US tax reforms. A major piece of any tax reform will be how to deal with $2.6trn in accumulated profits held offshore by US corporates. Any changes to the US tax code on this front could give a significant boost to US equities and the USD.”

“Unlike most advanced countries, the US code taxes profits earned by the foreign subsidiary of US companies. However the tax code also allows US corporates to indefinitely reinvest overseas earnings offshore and defer paying the full 35% corporate tax rate on these profits until they are officially repatriated back the US, through a dividend or otherwise transferred back to the US parent. To avoid paying the tax US corporates have hoarded substantial sums overseas, about $2.6trn.”

“The US presidential election has given fresh impetus to a repatriation tax holiday as part of a broader overhaul of the US tax system. The exact timing is uncertain but it’s reasonable to assume that legislation will be passed in late 2017 and implemented in 2018.”

“The potential boost to the economy is questionable, even if the legislation requires that the funds be earmarked for hiring and investment like 2004. Payrolls and investment were solid in 2005 during the repatriation tax holiday but they were solid in 2004 and 2006 too. The current $2.6trn hoard overseas is highly concentrated in the tech, energy and pharmaceuticals industries - industries that already enjoy more free cash than they know what to do with. In any case, creative structures allow US companies to regularly access these offshore profits. For example some corporates such as Apple engage in “synthetic repatriation” borrowing in US capital markets against their overseas holdings to fund share buy backs and avoid paying the 35% tax.”

“Stocks will be the main winner. As in 2005, repatriated earnings are likely to be used to fund share buybacks.”

“The USD should be a big beneficiary too. About 30% of the stock of US earnings offshore was repatriated in 2005. Applying a similar ratio to today’s $2.6trn hoard implies a hefty $780bn+ in repatriation. But a substantial majority of that is probably already denominated in USD. Company filings from Apple and Microsoft, the two largest holders of offshore earnings show that 80%+ of their combined offshore earnings are maintained in USD securities.”

“Even so, 80% of earnings held in USD still implies a hefty $155bn+ in corporate demand for the USD. That is negligible compared to daily FX turnover but nonetheless represents yet another positive for the USD which is already enjoying solid support from increasing yield support and heightened EU political tail risks. The most vulnerable currencies appear to be EUR, CAD, GBP and CHF.”

“Beyond that there could be longer term ongoing benefits for the USD. A potentially significant decline in the US corporate tax rate from 35% to 15% (Trump's plan) or 20% (the House Republican plan) would reduce the incentive to hoard cash overseas, especially if the House Republican plan is adopted. Their policy calls for a one-time repatriation tax and then a shift to a "territorial system" of taxation, ending the US practice of taxing global earnings permanently.”