Unrepatriated Earnings as a Revenue Source: Lessons Learned from the AJCA
House Republicans and the Trump administration both agree on one very reliable and quantifiable source of funding to pay for their ambitious tax rate reduction plans: foreign earnings that U.S. multinationals currently have “reinvested” offshore and deferred from U.S. income taxation (at current U.S. rates up to 35 percent). While Congress and the White House have offered some details as to how they might tap this great resource (e.g., reduced rates of tax, multiple years to pay, etc.), specifics on a one-time tax of offshore earnings are few and far between. With many U.S. based techs flush with earnings deferred through offshore structures, industry leaders are closely eyeing the mechanics of this proposal item.
Fortunately for the armies of Congressional staffers charged with the daunting task of drafting new tax laws, we do have a recent legislative benchmark to look to: the American Jobs Creation Act of 2004 (AJCA). The AJCA included a temporary dividends-received deduction for certain foreign repatriations. Under that temporary provision, 85 percent of foreign dividend distributions that satisfied certain conditions were tax-free, with a ratable reduction to any foreign tax credits carried by those distributions.
The tax writers may very well look to the AJCA for ideas for another one-time tax holiday, or perhaps for lessons learned in devising a better plan. At the moment, there are numerous open questions. The following are just a few examples.
- Will the new provision be designed as a tax holiday for repatriated profits, à la the AJCA, or will a reduced rate of tax be applied to all pre-effective date foreign earnings, regardless of whether they are repatriated? The former would encourage repatriation. The latter would give Congress access to a larger revenue source, leaving the decision of whether to repatriate to the taxpayer’s non-tax considerations.
- Will the reduced rate be applied equally to all earnings abroad or will the dual rate system proposed in the House Blueprint take effect (3.5 percent on non-cash earnings and 8.75 percent on cash earnings)? With a significant portion of your company’s earnings tied up in intellectual property or physical assets, could this reform item equate to “phantom income” for earnings reinvested in non-cash assets?
- Will there be a foreign tax credit available against this one-time tax? Will Congress impose a ratable reduction to any foreign tax credit in proportion to the lower rate of tax on the off-shore earnings? Or alternatively, might foreign tax credits be disallowed entirely, with the lower rate(s) for the one-time tax reflecting a built-in, hypothetical foreign tax credit benefit, with no credit for actual foreign taxes paid?
- In light of the impending changes, might there be a benefit to bringing back high-taxed foreign earnings before the effective date to get full benefit for previous foreign taxes under the present foreign tax credit rules?
While we collectively wait for this hazy picture to come into focus, a quick refresher on the AJCA and IRC Sec. 965 may be in order — odds are Congressional staffers are already doing just that.
Author: Brendan Sinnott
We’d love to get your thoughts: How would a deemed repatriation factor into your cash flow forecast? Has your company modeled the impact of the Trump proposal versus House Blueprint? Please call or email us and let us know!
