The Treasury Department and Internal Revenue Service on January 13 issued guidance (Notice 2005-10) for U.S. companies planning to repatriate earnings from controlled foreign corporations (CFC’s) qualifying for the temporary special deduction under the American Jobs Creation Act (AJCA), enacted in October 2004.
The following outlines important highlights.
New section 965 of the Code allows U.S. companies to elect, for one taxable year, an 85% dividends received deduction (DRD) for eligible "cash dividends" received from their CFC’s, subject to certain limitations. The company must invest the repatriated cash in the United States pursuant to a domestic reinvestment plan approved by top management prior to the repatriation. The DRD results in dividends from a foreign subsidiary being taxed at an effective maximum U.S. federal income tax rate of 5.25%.
The guidance contained in the notice is generally favorable. The only material item excluded from taxpayer’s wish list’s is the ability to use the proceeds to buy back shares.
Notice 2005-10 provides guidance regarding:
- The meaning of the term "cash dividend"
- Requirements for a valid domestic reinvestment plan
- Permitted and non-permitted uses of proceeds
- Mechanics of making the election
- Information reporting requirements
- Safe harbor for use in establishing that the U.S. investment requirement is satisfied
Cash Dividends. The guidance provides that the term "cash" includes both U.S. dollars and foreign currency, and that the liquidation by a foreign subsidiary of its investment in cash equivalents, followed by a cash dividend to a U.S. shareholder and a temporary reinvestment by the U.S. shareholder similar in cash equivalents, may qualify.
Cash dividends paid to a partnership or disregarded entity owned by a U.S. shareholder will be treated as a cash dividend received by the U.S. shareholder if the entity distributes the cash to the U.S. shareholder. Loans by the entity to the U.S. shareholder will not be considered distributions for this purpose.
Dividend Reinvestment Plan. The plan must describe specific anticipated U.S. investments, state a reasonable time period during which the company anticipates completing the investments, and the total dollar amount for each principal investment. Companies are not required to trace or segregate the repatriated funds, but must demonstrate that an amount equal to the amount of repatriated funds has been invested under the plan. Inclusion of investments made with cash in the election year or later, even if already planned and budgeted for prior to approval of the plan, is permitted.
The Notice contains a non-exclusive list of expenditures that will be treated as permitted or non-permitted expenditures for purposes of the reinvestment requirement.
Payments to Unrelated Persons. Expenditures are permitted investments only if they are made to a person that is not related to the taxpayer (within the meaning of section 267(b)).
Cash Payments. In general, permitted investments must be made in the form of cash. If a taxpayer issues a note in payment for what would otherwise be a permitted investment, the permitted investment is considered to be made only as the taxpayer satisfies its obligation under the note in cash.
Stock may not be used to make permitted investments. Thus, for example, if a taxpayer issues stock to acquire a target corporation, such acquisition is not a permitted investment (unless, and only to the extent that, cash also is paid for the target company). Similarly, compensation in the form of stock grants or stock options is not a permitted investment.
Funding of Worker Hiring, Training, and Other Compensation. Expenditures incurred in connection with the funding of U.S. worker hiring and training are (with the exception of executive compensation) permitted investments. In general, the funding of worker hiring and training includes expenditures incurred in connection with hiring new workers and training both existing and newly-hired workers in the U.S. and expenditures incurred on compensation and benefits. However, cash paid to executives will not qualify.
Infrastructure and Capital Investments.
Expenditures incurred in connection with the funding of infrastructure and capital investments in the U.S. are permitted investments. Expenditures for infrastructure and capital investments include physical installations and facilities that support the taxpayer’s business, and other assets integral to the conduct of a business, provided that the infrastructure and capital investments are located and used in the United States.
Research and Development.
Expenditures incurred in connection with the funding of research and development are permitted investments; provided that the research and development activities are performed in the United States.
Expenditures for research and development may be permitted investments even if the research and development is not performed by employees of the taxpayer, provided such expenditures are borne by the taxpayer and the activities are performed in the United States.
Repayment Of Debt. The repayment by the taxpayer of debt, regardless of whether the lender or holder is a U.S. person, is a permitted investment so long as the repayment contributes to the financial stabilization of the taxpayer for the purposes of job retention or creation in the United States The repayment of debt ordinarily will be considered to contribute to the financial stabilization of the taxpayer because it improves the taxpayer’s debt-equity ratio and reduces the taxpayer’s obligations for debt service. Taxpayers must not again borrow funds (pursuant to a plan).
Qualified Plan Funding. The satisfaction of an obligation to fund a qualified benefit plan ordinarily will contribute to the financial stabilization of the taxpayer.
Other Expenditures. Expenditures other than those described above are also permitted if such expenditures contribute to the financial stabilization of the taxpayer for the purposes of job retention or creation in the United States.
Acquisitions of Interests in Business Entities. Generally, the acquisition of an ownership interest in a business entity (such as a corporation or a partnership), regardless of whether such entity is domestic or foreign, is a permitted investment to the extent of the percentage of the total value of the gross assets owned (directly or indirectly) by the business entity that, if acquired directly, would be permitted investments. The direct or indirect acquisition of an interest in a business entity is a permitted investment only if the taxpayer directly or indirectly owns an interest representing at least 10% of the value of such business entity after the acquisition; look through rules apply to tiered entities.
Advertising and Marketing Expenditures. Expenditures incurred on advertising or marketing with respect to trademarks, trade names, brand names, or similar intangible property are permitted investments, provided the advertising or marketing activities are performed in the United States.
Intangible Property. Expenditures to acquire the rights to intangible property, through purchase or license, are also permitted investments, but only to the extent the rights to the intangible property are used in the United States.
- Executive Compensation
- Intercompany transactions
- Dividends and other shareholder distributions
- Stock redemptions
- Portfolio investments (investments in less than 10%-owned business entities)
- Debt instruments
- Tax payments
‘Sixty Percent (60%)’ Safe Harbor. The guidance provides a safe harbor for a taxpayer to use to establish that the amount of the dividend has been invested as required by the statute. To qualify for the safe harbor, expenditures comprising at least 60% of the amount of total funds must have been made or be the subject of a binding contract or commitment entered into with unrelated persons by the end of the second taxable year following the year of the taxpayer’s election, and the expenditures must be permitted investments that are specifically listed in Notice 2005-10.
In addition, the taxpayer must satisfy certain reporting requirements for the year of the taxpayer’s election and for each of the two subsequent taxable years (unless all investments have been made pursuant to the plan before the beginning of either of the two subsequent taxable years). Finally, the taxpayer must satisfy certain documentation and production requirements.
Additional Guidance Planned. Treasury Department officials stated at a January 13 briefing that taxpayers can expect to see additional section 965 guidance on issues including the effect of mergers and acquisitions on the so-called "base-period average," foreign tax credit calculations, and expense disallowance. Officials did not offer a timetable for issuing the guidance, however.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.