Submitted by John Beasley…
Investing in the USA is a difficult challenge. The Federal Government taxes production, which drives up the wholesale cost of goods by about thirty three percent. That provides the offshore competition that enjoys a value added consumption tax with a decided advantage. The Federal Government also establishes wage and benefit guidelines for industries. These guidelines work best for companies that receive cost adjusted government contracts. The long-term effect of Federal Government regulation of the economy is to inflate the “cost of good sold” which limits competition while making American products less competitive internationally.
Let’s look at a simplified business model and see how someone might invest in the USA. The Solomon Brothers inherited their dad’s decorative tin can company. By the 1990’s it was difficult to compete against Asian imported decorative tin cans. The Brothers decided to begin importing products such as French, German and Danish Cookies, Asian watches and wallets, as well as ladies cosmetic kits and first aid kits and selling them in their decorative tin cans. They sold their products at the wholesale trade marts and directly to smaller retail chains. The plan worked very well. The Brothers began to owe a lot of income tax.
Their next step was to move the tin can company to a “free trade zone” inside the USA. This allowed them to import and technically “assemble their products” outside of the USA. Many of the products they assembled at their factory were destined for export. Since all the products put in the tin cans were imported, the “value adding” to those products was done outside of the USA. Therefore, the profit could legitimately be taken before importing the products into the USA. This strategy is much like US automobile companies that establish a subsidiary operation, typically in Canada or Mexico, to build their engines and transmissions. They take the profit on these components before importing them into the USA. Automobile companies often have a difficult time making money on business operations in the USA. This strategy of “value adding” outside of the USA saved the Brothers an amazing amount of money on taxes. Equally important, the Brothers did not have to employ all the investment tax loopholes that are intended to generate business for the US economy at the expense of a company’s liquidity.
A question the Brothers analyzed, What if they took too much profit on their import items and their tin can company in the USA lost money? Could these operating losses be converted into tax credits, which could then be used to shield income from other business operations? The Brothers bought an aluminum boat manufacturing company and began exporting workboats and landing craft using the business model they had established with the tin can company.
For comparison purposes, if we consider Mercedes-Benz purchase of Chrysler back in 1998, Mercedes-Benz invested about thirty-five billion into Chrysler. Part of that investment was billions of dollars worth of German equipment installed at the Chrysler factories. In theory, Mercedes-Benz sold eighty percent of their equity in Chrysler in 2009 to a private equity business partner for $7.4 billion. Mercedes-Benz loss was estimated at $27.5 Billion. At a thirty-five percent tax rate that loss had a cash value of over $10 billion dollars as a tax shield for other profitable investments in the USA. That tax loss was available in current dollars to shield current income from operations in the USA. Taking the investment loss on Chrysler could well have been more profitable, that is, provided a higher “net present value return” for Mercedes-Benz than holding that investment long term and depreciating the investment as required by US tax laws. The recovery of investment capital takes too long in the USA. Even using accelerated depreciation schedules; the equipment is often worn out or in need of renovation before it is completely depreciated.
Traditionally, for the last fifty years, the average yield on publicly traded stocks was 10.7 percent annually, before the Federal Reserve started pumping liquidity into the stock market. Shielding investment income from Federal Income Tax could improve that 10.7 percent yield by about one third. This is something every company operating in the USA has to consider, is it more profitable to take a paper loss in the USA than it is to actually take a profit in the USA?
The statements, views and opinions expressed in this column are solely those of the author and do not necessarily represent those of The Duran.