On September 18, Microsoft Corporation (MSFT) announced that it would increase its quarterly per share dividend payout from $.20 to $.23. We were so disappointed in the “incrementalist” dividend increase implemented by Microsoft, we expressed our desire that Microsoft should just bite the bullet and pay the up to 35% repatriation tax on its $50B of net foreign liquidity to pay shareholders a special dividend of $4/share. While we still stand by our original proposal, we felt duty bound to follow up our report by offering a substitute proposal to liberate Microsoft’s foreign source liquidity that does not result in Microsoft paying $17.5B to repatriate the foreign source liquidity to return it to shareholders.

We were originally going to propose that Microsoft’s foreign source subsidiaries would repurchase the shares and due to the effects of consolidating intercompany transactions in the financial accounting and reporting process, this would serve to effectively return cash to shareholders and reduce shares outstanding for the company. Unfortunately, International Business Machines‘s (IBM) blatant use of this repatriation mechanism ruined it for everyone else.

On May 29, 2007, IBM announced that it would use a foreign subsidiary (IBM International Group) to initiate an accelerated share repurchase program to repurchase $12.5B of its stock. Two days later, the Internal Revenue Service declared that it would disallow any similar transactions with regards to avoiding corporate repatriation taxes. In IBM’s case, IBM International Group would buy the shares in the capital markets and then use the shares to pay its corporate parent for goods and services. We think that in this case, IBM ended up being too cute by half with regards to this program. We would have suggested that IBM International simply serve as the IBM entity that buys the shares back on the open market.

We also believe that the company could have and should have tapped its cash flows through intercompany loans. We were surprised that a US Senate Committee memo said that its fellow tech also-ran Hewlett-Packard (HPQ) used loans from its foreign operations to its US operations in order to tap foreign source cash. We were surprised that the IRS did not object to this deal, but we saw how HPQ structured the loans to comply with the tax laws.

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