The $62bn secret of Warren Buffett’s success
We’ll send you a myFT Daily Digest email rounding up the latest Burlington Northern Santa Fe Corp news every morning.
Warren Buffett is one of the most famous, and certainly the richest, proponents of raising taxes. What is less often remarked upon is that he is also a leading proponent of delaying tax payments as long as possible.
In the latest and largest example, Mr Buffett’s Berkshire Hathaway has been able to defer $61.9bn of corporate taxes, the company revealed in its annual report.
This figure — about eight years worth of taxes at Berkshire’s current rate — is a reminder that Mr Buffett understands how putting off the moment when taxes are due gives him more money today to invest elsewhere.
It is also a reminder that a savvy approach to taxes has always been a feature of Mr Buffett’s career, even as Berkshire has grown to become one of the biggest corporate contributors to the US Treasury.
The total of deferred taxes reported by Berkshire for the end of 2014 is more than five times the level of a decade ago, following Mr Buffett’s move into more capital intensive businesses, with the acquisition of BNSF railways and a string of US power companies.
The US tax code encourages capital investment through the way it treats the depreciation of assets such as power plants and rail infrastructure, allowing companies to record profits that are not taxed until later in the life of these assets. Congress expanded these incentives for business investment in the wake of the financial crisis.
Berkshire’s Energy unit also receives tax credits for renewable power generation — reporting $258m of wind energy tax credits in 2014, and $913m of investment tax credits in 2012 and 2013 for opening new solar power plants.
Until Berkshire’s tax comes due, Mr Buffett is able to use the money for other investments with returns compounding over time — a situation he has described as an interest-free loan from the government.
In 2014, Berkshire paid $4.9bn in taxes, according to its statement of cash flows, but it will ultimately have to pay $7.9bn on its profit from last year. Because 85 per cent of its revenues come from the US, it has fewer opportunities than other multinational companies to minimise taxes by ensuring profits are recorded in low tax jurisdictions.
As a result, Berkshire’s effective tax rate has fluctuated between 31.1 and 28.2 per cent in the past three years. By contrast, General Electric — after Berkshire, the largest US conglomerate — has reported a tax rate between 14.6 and 4.2 per cent, while Apple, the world’s largest company, pays between 26.2 and 25.2 per cent. The standard US corporate tax rate is 35 per cent.
Deferred tax is one of two forms of interest-free leverage used by Berkshire. Mr Buffett also invests premiums from Berkshire’s insurance businesses in the period before they have to be used to pay claims. The size of that insurance “float” increased by $7bn to $84bn in 2014, according to its annual report.
Mr Buffett declined to comment for this article. However, Whitney Tilson, Berkshire shareholder and founder of Kase Capital, says: “He has always been savvy. Buffett gets a lot of flak from people who really hate the fact that he wants to raise taxes on rich people. But it is not at all hypocritical to believe that tax rates are too low and to manage a business so as to keep its tax rate as low as possible.”
This tax savvy has been of benefit to Mr Buffett’s followers since the very beginning of his association with Berkshire, 50 years ago. When he assumed control of the company, originally an ailing textile manufacturer headquartered in Massachusetts, it was paying no taxes because of losses sustained in previous years.
Berkshire also does not pay a dividend, on the grounds that Mr Buffett believes he can find market-beating investment opportunities for the money. Defending the practice in his 2012 annual letter, Mr Buffett reminded shareholders that they would all have to pay tax on those dividends. Investors who need cash should sell a portion of their shares, incurring tax on only the capital gain, he said.
In his latest shareholder letter, released last weekend, Mr Buffett mounted a full-throated defence of Berkshire’s conglomerate structure, citing the tax benefits that it brings.
“At Berkshire, we can — without incurring taxes or much in the way of other costs — move huge sums from businesses that have limited opportunities for incremental investment to other sectors with greater promise,” he said.
One of Mr Buffett’s mantras is that “Berkshire’s favourite holding period is forever”, and, in his letter, he reiterated his commitment never to sell a Berkshire subsidiary — something that would most likely result in a capital gains tax bill.
But Berkshire has been able to exit several longstanding and highly profitable investments in recent years, without triggering capital gains payments, thanks to unusual asset swap deals.
Last year, it agreed to exchange its $4.7bn holding of Procter & Gamble shares, on which it had made a profit of more than $4bn, for the P&G subsidiary Duracell. Tax on the capital gain will not be paid unless and until Berkshire sells Duracell, another $1bn-plus tax liability that may never come due.
The Duracell deal was the third such asset swap in a year. Mr Buffett exchanged a minority stake in Graham Holdings, former owner of the Washington Post and a Berkshire investment since the 1970s, for a TV station, and swapped a stake in Phillips 66 for a subsidiary of the energy company.
The level of deferred tax at Berkshire is likely to keep rising over time, however, as Berkshire racks up further on-paper gains from its stock holdings and pursues capital investment such as a $6bn programme this year to upgrade the BNSF railway.
Mr Tilson applauded Mr Buffett’s sensitivity to taxes as an important contributor to his long-run success. “You can only eat after-tax returns,” he said.
Letter in response to this article:
Buffett strategy will mean others pay more tax / From Jonathan Neuber