The Effect of Permanently Reinvested Foreign Earnings on Stock Prices
U.S. multinational corporations (MNCs) that operate in low-tax rate foreign jurisdictions and reinvest their foreign earned income abroad can garner large tax savings. If a U.S. multinational faces, on average, foreign tax rates below the U.S. statutory rate (that is, the MNC is in an excess limit position), the imposition of any residual U.S. tax (and of foreign withholding taxes) generally is deferred until the low-tax rate foreign income is repatriated to the United States. The benefit of this residual U.S. tax (and foreign withholding tax) deferral, however, is recognized in consolidated financial statement income and retained earnings only if management represents that the repatriation of the foreign income will be postponed indefinitely. In such cases, the foreign earnings are designated as permanently reinvested foreign earnings (PRE), and any potential tax expense associated with repatriation is not recognized. This chapter examines the international tax deferral benefits that MNCs communicate through their financial statements and investigates the U.S. stock market's valuation of these benefits. The purpose is to assess the effect of PRE on stock prices.
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