Friday, June 3, 2011

U.S. Tax Rules Affect Microsoft Dividend Policy

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Microsoft, the U.S. software developer, generates large amounts of cash from the sale of its products. In its fiscal year ending June 30, 2010, it generated more than $24 billion in free cash flow. On the same date, it sat on almost $37 billion in cash and short-term investments.

Microsoft began paying a dividend only in 2003 -- it currently pays $0.13 per quarter or $0.52 per year. With the share price recently hovering around $25, that's about a 2% return to shareholders. Many of those shareholders want Microsoft to do more, realizing that, with 8.65 billion shares of common stock outstanding, the dividend costs Microsoft only $4.5 billion a year, a small portion of its cash hoard. 

A recent story by Bloomberg indicates that Microsoft would like to do better by its shareholders, but is constrained by U.S. tax laws. According to Bloomberg sources, about one-half of Microsoft's cash flow is generated outside the U.S. Under Subpart F of the Internal Revenue Code, that cash is not subject to U.S. tax until it is repatriated to the U.S., and Microsoft has managed to keep its effective U.S. tax rate low (26.5% in year-end 6/30/09) by retaining a significant portion of its earnings offshore where they are earned. According to Bloomberg, Microsoft is considering issuing debt to raise the cash to increase its dividend. Not only would this avoid the repatriation (and taxation) of overseas earnings, the interest paid on the debt should be fully deductible.

Using debt to pay a dividend makes economic sense only in light of the tax savings, and illustrates the contortions that multinationals can subject themselves to when responding to tax incentives. In the American Jobs Creation Act of 2004, Congress enacted a one-time holiday that allowed U.S. corporations to repatriate cash from their controlled foreign corporations at a greatly reduced tax rate. But that tax holiday required that the repatriated cash be invested in U.S. infrastructure and employees, not shareholder dividends. Absent basic reform of the U.S. international tax system, it is likely that Microsoft will be going to the credit markets.

Harold W. Pskowski, Managing Editor, U.S. International Tax.

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