IRS tax loophole

-IRS moved to shut a corporate tax loophole last week, two days after IBM used it for stock repurchase. -Typially, a U.S company will be subject to double taxation mechanism when it repatriate earnings from overseas to U.S, one taxed by foreign government and one by U.S. At the same time, the company get tax credit from U.S to offset its payment for foreign taxes. The U.S tax rate is second highest, 40% for interests and dividends. -Through Trangular reorgnization, IBM set up a freign subsidiary in Netherlands. The subsidary borrowed monay and oversee earnings ($1 bil) to buy backed $12.5 billion (8% shares outstanding) without funneling money back to U.S (called Killer B). So it is not subject to U.S tax. Even more , IBM will use its oversea earnings to pay back loans ($11.5 bil). In this way, $12.5 bil earnings are immune from U.S tax. This explained its first quarter tax rate is only 29.5%. -The new regulation will treat funds use for buybacks as repatriated earnings, making them subject to U.S corporate tax rates. How did IBM make it -- accelerated share repurchase International Business Machines Corp. said it has spent $12.5 billion to buy back its stock in one of the largest uses of an "accelerated share repurchase," a tactic that allows a company to boost per-share earnings more rapidly than it would using a conventional buyback approach. In the complex deal, IBM created a Netherlands unit to finance the stock repurchase with overseas earnings and avoid having to repatriate funds, which would make them subject to higher U.S. taxes. IBM said it bought 118.8 million of its shares at $105.18 apiece from three investment banks that borrowed the shares from investing institutions, in a typical pattern for accelerated plans. The banks, in turn, will purchase an equivalent number of shares on the open market over the next nine months, and return the borrowed shares. IBM may pay more money to the banks if the average price of IBM stock rises during that period. The overseas element, lawyers said, is an unusual twist. IBM established a wholly owned subsidiary in the Netherlands, IBM International Group, to own its international operations and repay the loan taken out by IBM to buy the shares. IBM International will pay principal and interest on the loan with cash generated by IBM International outside the U.S. IBM treasurer Jesse Greene said the offshore tack, which he said has been used by "a few" other companies," will allow IBM to lower its taxes by using foreign units' funds without having to repatriate them to the U.S. Repatriation often results in a tax bill from the U.S. if the monies being returned are profits that have been taxed abroad at a lower rate. "There's an opportunity to use some of that cash overseas without being taxed again in the U.S.," he said. He declined to disclose the difference between IBM's U.S. and international tax rates. For the first quarter, IBM's world-wide tax rate was 29.5%. Accelerated share repurchases have become increasingly popular with big companies doing buybacks. The accelerated plans immediately reduce shares outstanding, increasing earnings per share. However, critics say the accelerated plans can hurt companies if the stock rises sharply, forcing them to pay more than expected later. The share purchases equal about 8% of IBM's stock outstanding and were authorized under a previously announced plan to buy $15 billion in shares. IBM said it borrowed $11.5 billion for the initial purchase from a group of banks and will pay $1 billion in cash. IBM announced the repurchase after the close of regular trading. IBM shares rose 73 cents to $105.91 in 4 p.m. New York Stock Exchange composite trading and another 8 cents to $105.99 after hours. IBM said that as a result of the stock buyback, it expects 2007 growth in earnings per share of 13% to 14% compared to the 11% forecast that it made when it reported earnings for the first quarter. It said the reduced shares will account for two to three points of growth, or 14 cents to 17 cents a share. Three cents of the benefit will occur in the current quarter with the remainder in the second half of the year. Mr. Greene said in an interview that IBM believes "we'll get a very similar result" to a traditional share repurchase program on the open market. He noted that IBM isn't spending all the authorized $15 billion, and he said it still has $1.4 billion available under a previous buyback authorization. IBM announced the planned buyback at its annual meeting in April, and the stock has risen since in anticipation of the reduced share float, analysts say. IBM touted the big buyback as a way to take advantage of its strong cash flow and return money to shareholders.