Magazine

The Taxman Barely Cometh


A look at which companies pay the least—and how proposed reforms would affect profits from abroad

When it comes to racking up tax deductions, many companies display both ingenuity and determination. Thanks to a wide array of credits, exemptions, and deferrals, they have a variety of ways to cut the amount they pay the IRS every year.

House Ways & Means Chairman Charles B. Rangel (D-N.Y.) would like to change that. On Oct. 25, he unveiled a bill that would lower the corporate tax rate from 35% to 30.5%. To make up the lost revenue, Rangel would eliminate some popular tax breaks. While the representative's specific plan is not expected to become law exactly as is, his overall approach to simplifying the corporate tax code has drawn a lot of support.

To identify who might be affected by the type of corporate tax simplification advocated by Rangel, BusinessWeek asked data tracking outfit Capital IQ (MHP) to calculate which companies in the Standard & Poor's 500-stock index spent the lowest percentage of their earnings in cash on taxes over the past five years. The data reflect the most recent five-year period available, 2002 to 2006. These are the companies that are, in other words, getting the most mileage out of the various exceptions in the tax code.

At the head of the list: utility CMS Energy (CMS) (0% of earnings spent on taxes on average over the past five years); natural gas driller Chesapeake Energy (CHK) (0.3%); airplane manufacturer Boeing (BA) (0.7%); semiconductor maker Broadcom (BRCM) (1.1%); and utility Florida Power & Light (FPL) (1.2%). For the entire S&P 500, by contrast, the average percentage of earnings spent on taxes was 26%—still well under the 35% stated corporate tax rate. (A detailed list of the 100 companies that paid the lowest percentage of earnings in taxes is available at businessweek.com.)

CREDITS AND ARBITRAGE

There is nothing wrong, of course, with minimizing taxes, and nothing in the Capital IQ analysis suggests these companies broke any rules. Our goal was to figure out which companies legally paid the lowest tax rates and how they did it. The ones that made it to the top of the list managed to do so in several different ways. Big exporter Boeing benefited in part from a now discontinued tax break for domestic manufacturers that sell goods overseas. An executive says that it is unfair to evaluate the aerospace company's tax payments on a five-year time frame since its business is based on multi-decade investments and liabilities. FPL Group, the Florida utility, got tax credits for investing in wind power and write-offs for big hurricane losses. And low-tax champ CMS Energy, a Jackson (Miss.) utility, says that it lost lots of money through bad investments. "We will get back to paying taxes again, and we look forward to that day," says Chief Financial Officer Thomas J. Webb.

The biggest tax-avoidance strategy targeted by Rangel is what might be called cross-border tax arbitrage—taking advantage of the difference between higher U.S. rates and lower rates abroad. Companies can do this because they do not have to pay taxes on earnings from their overseas operations until the income from those operations is brought back into this country. One of the big beneficiaries of this rule is semiconductor manufacturer Broadcom, which calls Irvine, Calif., home but makes most of its goods in low-tax countries such as Singapore. It then ships them directly to overseas customers.

STRADDLING BORDERS

Last year Broadcom lost $336 million in the U.S., where it runs some costly research and development operations, but earned $703 million overseas. Rangel's proposal would make such moves harder to pull off by barring companies from deducting expenses that are incurred in the U.S. but related to overseas earnings—until that income is repatriated. Rangel estimates the change would raise a total of $106 billion over 10 years. (Broadcom did not respond to e-mails or phone calls.)

Several other technology and pharmaceutical companies appear to be following the same playbook, according to studies by economist Martin A. Sullivan, a contributor to the journal Tax Notes. "It's remarkable how [often] there were losses in the U.S. while companies were profitable overseas," says Sullivan. "They want to get profits out of the U.S. if taxes are lower offshore, which they generally are."

EMERGING UNSCATHED

While corporate tax simplification could drive up costs for many of the companies that pay the lowest rates, others would likely remain untouched. Rangel, for example, seems to have no intention of eliminating the breaks that encourage the production of alternative energy in the U.S. That's good news for Chesapeake Energy. The Oklahoma City-based company has paid only 0.3% of its income in taxes over the past five years due to extensive drilling for natural gas, an activity the government wants to encourage. Chesapeake has twice as many rigs in service as the next most active company. A spokesperson predicts the company's tax rate will increase as natural gas drilling becomes a smaller part of its business. Similarly, SEC filings indicate FPL has gotten $400 million in tax credits from building wind power facilities. So long as oil prices remain high, that's likely to remain a popular cause—and the tax break that the utility is using will probably remain intact.

To calculate the information in this story, Capital IQ (like BusinessWeek, a division of The McGraw-Hill Companies (MHP)) turned to a database of financial and management information that it searched for each company's "cash taxes paid," a figure generally reported on cash-flow statements or in the annual report footnotes. That figure was then compared with each company's earnings before taxes. Real estate investment trusts, companies based outside the U.S., and businesses with insufficient data, among others, were dropped from the list, leaving a total of 466 companies under consideration out of the entire S&P 500.


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