December 8, 2017 / 4:31 PM / a month ago

U.S. tax repatriation plan may not cure long-term dollar weakness

NEW YORK (Reuters) - Investors looking for the U.S. Republican tax bill to prompt multinational companies to convert foreign profits into dollars and end the worst slide in the greenback in a decade may have to temper their hopes for a prolonged rebound.

The plan, designed in part to give U.S. multinationals a reason to repatriate the roughly $2.6 trillion in profits held by their foreign subsidiaries, would slash tax rates on such previously accumulated earnings. Companies have been slow to recognize those profits on their balance sheets so they can avoid paying U.S. corporate taxes, which stand at a rate of 35 percent. (Graphic: Overseas Cash Stash - reut.rs/2ABRzTu)

The dollar is down roughly 8.1 percent so far this year against a basket of currencies. The greenback has suffered as the Federal Reserve has raised interest rates more slowly than expected and President Donald Trump has not been able to sign any major legislation into law. (Graphic: Dollar Rise During 2005 Tax Holiday - reut.rs/2A77Y5o)

Yet analysts say that even if the tax bill becomes law, the dollar may not benefit in the long term because the legislation gives companies little incentive to convert their foreign profits right away. At the same time, many large companies already have those profits in dollar-denominated securities.

The Republicans’ proposals differ from the last tax break on foreign profits, which global financial services company Unicredit said brought roughly $300 billion to the United States.

The bill President George W. Bush signed in October 2004 drastically reduced tax rates to 5.25 percent over a 12-month window and, along with aggressive tightening by the Federal Reserve, helped send the dollar nearly 13 percent higher the following year.

This time, however, the Republican bills before a conference committee would permanently change how U.S. companies’ foreign profits are taxed.

The United States would no longer collect taxes on most future earnings a company makes beyond its borders. As a result, companies would have fewer incentives to bring previously accumulated foreign profits home quickly because rates are not scheduled to revert higher.

Up to $250 billion in foreign earnings could be repatriated over an indefinite period, according to TD Securities. While that could provide some boost to the dollar, repatriation will probably not be a significant ongoing factor in the $4.5 trillion global currency market, analysts said.

“It was a one-off repatriation and mandatory in 2005 so companies took advantage of it, and the dollar benefited from it,” said Mark McCormick, North American head of FX strategy at TD Securities in Toronto. “But this tax bill doesn’t have that same urgency.”

So far, there is no final version of the tax bill. Legislation passed by the House of Representatives would allow companies to bring back foreign profits at a 14 percent repatriation tax rate, as opposed to the current 35 percent, over eight years. The Senate bill, approved over the weekend, puts the rate at 14.49 percent.

Neither bill requires companies to convert foreign profits into dollars.

DOLLAR BULLISHNESS

Prospects of a tax break on companies’ foreign earnings and expectations of wider U.S. budget deficits helped boost the dollar to its highest levels since 2002 soon after Trump’s presidential victory in November 2016.

Now that the tax bills have passed both houses of Congress, “dollar bulls have started banging their drums” again, analysts at Unicredit said. However, they said this attitude is misguided because the vast majority of the earnings that companies will repatriate are probably already in dollar-denominated securities in the United States.

“Even a significant wave of repatriation might not lift the dollar directly, as some of the largest U.S. corporations already hold a lot of cash in dollar-denominated assets,” said Shaun Osborne, chief FX strategist at Scotiabank in Toronto.

In many cases, foreign profits are based in dollars held in accounts at U.S. banks, yet are treated as overseas assets on a company’s balance sheet. As a result, they are not recognized as U.S. income and are therefore not subject to U.S. taxes.

The Brookings Institution, a non-profit public policy organization based in Washington, estimates that at the 15 U.S. companies with the largest cash balances abroad, 95 percent of foreign profits are held in U.S. dollar-denominated cash or equivalents.

For example, Microsoft Corp noted in its annual report that as of June 30, roughly 92 percent of the cash and short-term investments held by its foreign units was already invested in U.S. dollar assets.

Despite some skepticism about U.S. repatriation flows, some analysts say the dollar could get a short-term boost.

“Immediately after tax reform is passed, you’re going to hear this giant sucking sound as money is heading home very quickly,” said David Woo, head of global rates and currencies research at Bank of America Merrill Lynch. Yet he does not expect a dollar rally to continue beyond the second quarter of 2018, partly due to concerns about the tax plan’s impact on the U.S. fiscal deficit.

Over the long term, the dollar will probably continue to slide, said Brian Jacobsen, multi-asset strategist at Wells Fargo Asset Management. The effects of the tax bill are already largely priced into the currency market, leaving little unexpected demand over the following 12 months, he said.

“We are positioning client portfolios for a little more dollar weakness,” he said. “Not strength.”

Reporting by Gertrude Chavez-Dreyfuss and David Randall; Additional reporting by Saqib Iqbal Ahmed and Megan Davies; Editing by Megan Davies, Jennifer Ablan and Lisa Von Ahn

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