RDP 2016-03: Why Do Companies Hold Cash? Appendix A: Tax Minimisation and Cash Management Behaviour of Multinational Companies

Media reports and academic research have suggested that the high cash holdings of US companies can be explained by the nature of the US corporate tax system and, in particular, the repatriation taxes that apply to multinational companies. However, there are reasons to suspect that this hypothesis does not explain the high cash holdings of Australian companies.

Broadly speaking, under both the US and Australian corporate tax systems, multinational companies pay taxes based on their worldwide income. In effect, the tax paid on foreign-sourced revenue is determined by the difference between the taxes actually paid abroad and the taxes that would be paid if the revenue had been generated domestically. However, there is an important difference in the timing of when these taxes are paid. In the United States, taxation takes place when earnings are repatriated (i.e. returned from overseas), while in Australia, taxation applies when earnings are earned. (That is, assessable foreign income needs to be included on the company's Australian tax return. The way in which an Australian company deals with the issue of ‘double taxation’ largely depends on the foreign jurisdiction within which the company operates.)

This tax structure provides some incentive to US companies to keep foreign earnings abroad in order to minimise their tax. These funds will tend to be held in cash in times of limited foreign investment opportunities.[25] Australian companies have less incentive to do this.

Despite the media attention, the academic literature is mixed on the effect of repatriation taxes on cash holdings, even for the United States. Foley et al (2007) looked at the contribution of repatriation taxes towards corporate cash holdings and found that companies that are subject to higher repatriation taxes hold significantly more cash. But, this finding was challenged by Bates et al (2009). The authors were able to identify companies with foreign pre-tax income and found no evidence that cash holdings increase more for companies with foreign pre-tax income. Pinkowitz et al (2013) also found limited evidence for the tax repatriation hypothesis. They compared US multinationals to other US companies and showed that the multinationals did not experience a greater increase in cash holdings. They also showed that the 2009 US corporate tax holidays – designed to temporarily reduce the tax cost of repatriation – did not reduce the cash holdings of multinationals.

While the repatriation tax motive may not apply in Australia, more broadly, Australian companies may still have incentives to accumulate cash reserves offshore for tax minimisation purposes. To examine this, we compared the conditional cash ratios of companies identified as having the lowest average annual effective tax rates (low tax companies) to the cash ratios of all other publicly listed companies in the Morningstar sample. The results (available upon request) suggest that the cash ratios of these two company groups were very similar, which suggests that tax avoidance is not a significant determinant of aggregate cash holdings in Australia.


US companies may also have a tendency to hold these funds in liquid instruments to give them flexibility to respond to changes to tax legislation that would enable them to repatriate their earnings, such as the US corporate tax holidays that were enacted in 2004. [25]