Opportunity for bringing overseas profits home: the American Jobs Creation Act of 2004 has bestowed an unprecedented temporary tax break on Corporate America. To use it--or lose it--is the quandary many are finding themselves in. Here is some advice for making the best decision for your company.
While the Act was signed into law by President Bush on Oct. 22, 2004, Congress has emphasized that, "there is no intent to make this [economic stimulus] measure permanent, or to 'extend' or enact it again in the future." Accordingly, U.S. companies must act quickly to determine whether they wish to take advantage of this incentive.
Section 965 of the Act allows a U.S. company (or a U.S. consolidated group) to elect for one taxable year to repatriate earnings from foreign subsidiaries at a reduced tax rate. It applies to a company's first tax year beginning on or after Oct. 22, 2004 (2005 for calendar-year taxpayers), or the preceding tax year (2004 for calendar-year taxpayers).
A U.S. company is permitted to deduct 85 percent of qualifying dividends, which equates to an effective tax rate of 5.25 percent. This deduction is only available, however, to the extent that the company properly invests the funds in the U.S. And, unfortunately, the law itself leaves open as many questions as it answers.
In an effort to fill in the blanks, the Internal Revenue Service (IRS) released the first in what is expected to be a series of notices in January. This notice provides guidance by specifying parameters for a company's domestic reinvestment plan and clarifying what constitutes a permitted U.S. investment. Overall, the IRS approach is quite flexible, allowing taxpayers considerable leeway in qualifying under this provision.
What Should U.S. Companies Do?
A U.S. company interested in taking advantage of this unprecedented opportunity should first assess how much of its foreign subsidiaries' earnings would be eligible for the reduced tax rate if they were repatriated. Generally, only cash dividends from foreign subsidiaries controlled by the U.S. company (or U.S. group) count.
Several limitations may apply to reduce the amount of eligible dividends. For example, only extraordinary dividends (dividends in excess of average repatriations in recent years) are eligible. Moreover, the amount of eligible dividends may not exceed $500 million, or the amount of earnings designated as indefinitely reinvested outside the U.S. under financial statement guidelines (APB 23), if greater. Once the amount of foreign earnings eligible for the dividends-received deduction is determined, the U.S. company must decide how to invest this amount in the U.S. and document these decisions in a domestic reinvestment plan.
Promoting U.S. Investments
The policy underlying section 965 aims to spur the U.S. economy and, in particular, U.S. job creation. With this objective in mind, the statute limits the benefit to amounts invested in the U.S., "including as a source for the funding of worker hiring and training, infrastructure, research and development, capital investments or the financial stabilization of the corporation for the purposes of job retention or creation." Recent guidance from the IRS expands on the statute by defining specific categories of "permitted" and "non-permitted" investments. Repatriated earnings spent on investments in the latter category are ineligible for the tax benefit. Thus, it is critical for companies to identify appropriate U.S. investments.
Under this provision, there is no requirement that the investment of repatriated funds in permitted uses represent incremental investments in those uses. Such investments are not required to exceed investments made in prior years or investments that were planned prior to the enactment of section 965. Thus, companies can use cash dividends received to fund U.S. investments that were already planned, such as for worker hiring or for any other permitted use.
Creating the Company's Plan
One of the key requirements in section 965 is to have a proper domestic reinvestment plan. Only repatriated funds that are invested in the U.S. pursuant to a domestic reinvestment plan are eligible for the tax benefit. IRS guidance is fairly flexible in this regard. A "domestic reinvestment plan" is merely defined as a written plan prepared by the U.S. company that describes in "reasonable detail and specificity" how the company intends to invest the repatriated funds.
The plan must be approved by senior management (the president, CEO or a comparable official) before the dividend is paid, and must subsequently be approved by the board of directors or a similar body. In the case of a U.S. consolidated group, these approvals must be made by the officials of the common parent of the consolidated group. The plan does not need to be separately approved by other members of the group, even if other members make permitted U.S. investments pursuant to the plan.
Companies are not required to "trace" or segregate the dividend proceeds they receive. The company must simply show that an amount equal to the amount of eligible dividends was invested in permitted U.S. investments, not that any specific funds were invested.
The fact that non-permitted investments are made during the same period generally will not affect the eligibility of the dividend. This saves U.S. companies from the administrative burden of tracking all of their dividends and allows companies more flexibility in making their U.S. investments. Nevertheless, once a dividend to which a plan relates is paid, the plan cannot be amended or otherwise modified. Companies therefore need a good plan upfront.
The recent IRS notice provides guidance on permitted U.S. investments. This is not an exclusive list, but does provide bright-line rules where none existed before. All of these expenditures must be payments to unrelated persons and generally must be made in cash. Subject to certain limitations and additional requirements, these investments include:
* Wages for U.S. workers (but not executive compensation);
* Infrastructure and capital investments;
* Research and development;
* Debt repayment;
* Funding of a qualified benefit plan;
* Acquisition of a 10 percent or greater interest in a business entity with U.S. assets;
* Advertising and marketing;
* Purchase or license of intangible property.
This list is limited to expenditures involving a U.S. connection, such as worker compensation, and is permitted to the extent it is attributable to services performed in the U.S.; intangible property may be acquired to the extent such rights are used in the U.S., etc. An array of other possible expenditures may also qualify, but only if they contribute to the financial stabilization of the company "for the purposes of job retention or creation in the United States."
There is no time limit for making permitted investments; however, the company's domestic reinvestment plan must set forth a "reasonable" time period anticipated for completion. To encourage investment in the near future, the IRS has provided a safe harbor for companies that complete their investments within a four-year window. Thus, and while what is "reasonable" may vary depending on the project, taxpayers would be wise to use discretion in determining the length of their investments.
Permitted investments made during the year of the election qualify for the deduction, even if the expenditure occurred prior to the payment of the dividend and/or prior to the adoption of the domestic reinvestment plan. Moreover, investments anticipated before the enactment of this law may still qualify, even if they were budgeted for or expected to be made with other funds. This "look-back" rule, together with the broad definitions of permitted investments, should permit most companies to easily find qualifying uses for amounts repatriated by controlled foreign subsidiaries.
The recent IRS guidance also lists certain non-permitted investments. Repatriated earnings cannot be used for any of the following:
* Executive compensation;
* Inter-company distributions, obligations and transactions;
* Dividends and other shareholder distributions;
* Stock redemptions/buy-backs;
* Portfolio investments (acquisition of a less than 10 percent interest in a business entity);
* Acquisition of debt instruments;
* Payments of tax, including any foreign or U.S. tax imposed on dividends that qualify under section 965.
It is important to note is that the list of non-permitted investments is largely symbolic, given the explicit acknowledgement that expenditures on permitted investments need not be incremental. A taxpayer anticipating non-executive compensation costs of $10 million in 2005 may repatriate $10 million from a foreign subsidiary, spend $10 million on non-executive compensation and spend the funds that would otherwise have been used for that purpose in any way it chooses, including any of the listed non-permitted investments.
Thus, the principal benefit of the lists of permitted and non-permitted investments is to reassure taxpayers that their dividend investment plans will not be challenged on audit by the IRS as long as all funds described in those plans are allocated to explicitly permitted uses.
Additional guidance from the IRS should further clarify the rules, particularly in some of the more technical areas such as foreign tax credits, and help taxpayers better evaluate the underlying risks. With careful planning and consideration, U.S. companies should be able to avoid the potential pitfalls of section 965 and successfully secure this possibly once-in-a-lifetime tax benefit.
Philip A. Stoffregen (email@example.com) is a principal in KPMG LLP's International Corporate Tax practice in Detroit. Shannon T. Malocha (firstname.lastname@example.org) is a senior manager in the International Corporate Services group of KPMG's Washington National Tax practice in Washington, D.C. (KPMG LLP (www.us.kpmg.com) is the U.S. member firm of KPMG International).
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|Author:||Malocha, Shannon T.|
|Date:||Apr 1, 2005|
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