With so many of the developed world's governments in so much debt, it is perhaps unsurprising that their attention has turned to tax and the extent to which it is - and is not - being paid. While tax evasion has always been illegal, tax avoidance schemes, though still legitimate, are receiving a lot more scrutiny – whether they are used by international companies, anonymous billionaires or well-known comedians.
One structure US companies employ in their tax planning is the 'double Irish Dutch sandwich', which may in theory sound like something you find in Prêt A Manger but in practice is a great deal less digestible. Effectively it enables a US company with large amounts of intellectual property to transfer profits through its corporate structure to Ireland, via Holland, where they are taxed at a more favourable rate.
As value investors, there are two reasons – beyond its eye-catching name – why we need to acknowledge the existence of this practice. First, there are a sizeable number of US companies that have made use of it and now have cash ‘trapped’ overseas because, were they to import it back to the US, it would be subject to the much higher tax rates in operation there.
As investors, when we look at a US company, we need to understand its true level of available cash – the amount it can call on to operate its business, pay dividends, buy back shares and so forth – and how much is offshore and less accessible. Then, when we are valuing such a company, it may be prudent to give the value of the overseas cash a 'haircut' to account for the higher domestic tax rates that are required before the cash can be put to use for corporate purposes.
The second point investors should note is that, where companies are currently enjoying tax rates significantly below the statutory rate of the countries in which they are incorporated, it would be prudent to assume the tax avoidance strategies they have used to achieve that could come under some pressure. This pressure would result in tax rates normalising and so any company we are considering investing in should be cheap even if paying a full tax rate – a perfect example of our hunting for companies where "heads we win, tails we don’t lose".
Here at the value perspective, we continually argue that investors should always ask 'what if?' and the 'double Irish Dutch sandwich'– especially in relation to companies, such as pharmaceuticals and technology businesses, that derive a lot of their earnings power from intellectual property. Again illustrating the importance of using your loaf.