Repatriating Foreign Earnings: Tax Breaks, Hedging And Job Creation, Part I

Like most pieces of legislation, the American Jobs Creation Act presents a number of opportunities for US taxpayers. One very important provision enables US multinational corporations of all sizes to repatriate foreign earnings that have been generated by their foreign subsidiaries in low-tax jurisdictions at a US federal income tax rate of 5.25 per cent or less. It is estimated that repatriation of foreign earnings under the Act may bring back as much as $350bn into the US economy.

Under the Act, foreign subsidiaries must pay repatriated earnings in cash and the earnings must be used to create or protect jobs for American workers under a detailed dividend reinvestment plan approved by management prior to the time the funds are repatriated. Now that the IRS has issued Notice 2005-10, which contains specific guidelines for compliance with the numerous conditions imposed by the Act, many CFOs are scrambling to understand their options under the Act. If you are such a CFO, understanding the Act and the best way to take advantage of its key provisions is of utmost importance.

What Requirements are Imposed on US Corporations that Wish to Take Advantage of the Act?

Under the Act, ‘United States shareholders’ of ‘controlled foreign corporations’ can elect in one taxable year to claim a deduction equal to 85 per cent of certain ‘extraordinary dividends’ received from controlled foreign corporations. This effectively reduces the maximum federal income tax rate on qualifying dividends from 35 per cent to 5.25 per cent or less.

For this purpose, a ‘United States shareholder’ is defined as “any domestic corporation that owns, directly or constructively, 10 per cent or more of the outstanding voting stock of the foreign corporation.” A ‘controlled foreign corporation’ is any foreign corporation in which United States shareholders own, in the aggregate, more than 50 per cent of the outstanding capital stock, by vote or value.

A distribution is an ‘extraordinary dividend’ only to the extent that 1) it constitutes a ‘dividend’ for US federal income tax purposes and 2) it exceeds in amount the average annual dividends (including certain deemed distributions and other adjustments) received by the US parent corporation from its controlled foreign subsidiary corporations during the five most recent taxable years ending on or before June 30, 2003. In determining this average, the highest and lowest years are excluded.

As the CFO of the US parent corporation, you can take advantage of this benefit only during the parent’s taxable year that either includes 21 October, 2004 or is its first taxable year beginning after that date by means of an election attached to a timely filed return for the year in question. The election may cover any number of extraordinary dividends received from any number of controlled foreign subsidiary corporations received by the US parent corporation or any domestic affiliates included in its consolidated US corporate income tax return during that year.

The dividend must be paid in US dollars by check or wire transfer. Consequently, in many, if not most cases, some or all of the repatriated funds will have to be borrowed by the foreign subsidiaries through asset-based loans secured with their overseas properties. In some cases, the US parent corporation may be able to guarantee those loans.

Domestic Reinvestment Plan

Once you have decided to repatriate earnings from your subsidiaries abroad and the means by which you will do so, you must prepare to reinvest those funds in the United States under a Domestic Reinvestment Plan that complies with IRS Notice 2005-10. The dividend must be paid under a detailed Domestic Reinvestment Plan that specifies the manner in which the proceeds will be used to create or protect the jobs of US workers employed by the US parent or its domestic affiliates. The Domestic Reinvestment Plan must be adopted in advance by executive management, but may receive the requisite board or other approval after the dividend has been received. The US parent will not be permitted to claim any foreign tax credits or deductions for any foreign income taxes or any foreign withholding taxes imposed on that portion of the repatriated earnings that is exempt from US federal income taxes under the Act.

Your Domestic Reinvestment Plan should follow the IRS guidance on what qualifies for dividend distribution and how the repatriated funds are permitted to be invested in the activities specifically designed to grow US-based businesses. Your company’s president, chief executive officer or comparable official must approve it before the dividend is paid. Other keys to formulating a successful strategy include 1) strict adherence to the rules prescribed in IRS Notice 2005-10, 2) timely remittance of the repatriated earnings in cash to the US, and 3) a reinvestment plan that covers as many permitted domestic uses of the repatriated earnings as possible, including those already on the drawing board or even under contract. Notice 2005-10 also contains safe harbor provisions (that are beyond the scope of this article) that must be scrupulously adhered to in order to preserve the 85 per cent dividends received deduction.

Creating Jobs Under the Act

The plan may include any number of provisions for use of the dividend in the United States. Remember, the objective of the American Jobs Creation Act is to do things that will create or retain jobs for American workers, including:

  • Worker hiring and training
  • Infrastructure and capital improvements
  • Research and development
  • Advertising and marketing
  • Acquisition of rights to intangible property, such as patents
  • Acquisition of at least a 10 per cent ownership interest in another business entity to the extent of the business entity’s assets constitute qualifying investments
  • Funding capital investments or financial stabilization for the purposes of job retention or creation including debt repayment
  • Funding qualified benefit plan obligations
  • Funding product liability or environmental claims

All of these activities have been interpreted as ‘job creation’ activities under the AJCA.

Prohibited uses include:

  • Payment of executive compensation
  • Payment of dividends
  • Redemption of stock
  • Debt investments
  • Portfolio investments (other than certain temporary payments)
  • Tax payments

CFOs looking to repatriate foreign earnings under the Act should take care to follow the AJCA guidelines and IRS rules on exactly how to design a Domestic Reinvestment Plan. A well thought out plan has the potential to allow a CFO to reap benefits that would not have previously been available.

  Repatriating Foreign Earnings: Tax Breaks, Hedging And Job Creation, Part II

This summary is not legal or financial advice, or recommendations to buy or sell currencies or engage in any other transactions, and does not purport to be comprehensive. Please consult your own advisor for the impact of these rules on your specific situation. Any reliance upon this information is solely and exclusively at your own risk.

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