United States: American Jobs Creation Act of 2004 - Repatriation Provision

Originally published October 25, 2004

Temporary relief from U.S. tax on repatriated foreign earnings was passed as part of H.R. 4520, the American Jobs Creation Act of 2004. This legislation received final congressional approval on Monday October 11 and was signed into law by President Bush on Friday October 22.

The temporary incentive for repatriation of foreign earnings presents a unique opportunity to access foreign earnings. Although various proposals for a repatriation tax holiday have been under consideration for the past two years, Congress made significant last-minute changes to the provision. Perhaps not surprisingly, the repatriation provision is complex and there are a variety of open issues multinational corporations need to consider before taking advantage of this legislation. Although not at all clear at this point, the Treasury Department may issue guidance on at least some of the issues discussed below.

A temporary deduction of 85 percent is available but only with respect to "cash dividends." The legislation generally excludes non-cash dividends, such as section 367 and 1248 inclusions; and also excludes non-dividend income inclusions, such as section 956 amounts and most subpart F inclusions. The new provision does permit cash dividends to be paid up a chain of CFCs to the U.S. shareholder despite the dividend being considered subpart F income upon receipt by a higher-tier CFC.

The temporary DRD is available only on that part of a U.S. shareholder’s total cash CFC dividend amount that exceeds its "base period average" dividend amount. There are a number of anomalies in the definition and calculation of the base period average, including that such average must take into account various types of inclusions (section 956 amounts and

distributions of PTI, whether or not attributable to current year dividends) that are excluded from DRD eligibility in the election year.

In addition, there is an issue as to whether section 956 amounts and distributions of PTI can be taken into account in determining whether the base period average has been exceeded. For many taxpayers the result can be a relatively high base period average that must be exceeded before a dividend is eligible for the DRD. In such cases, this base period amount will require careful planning to overcome, particularly in light of the risk of averaging high and low tax earnings when paying dividends necessary to overcome the base period average, as discussed below.

The U.S. shareholder must establish a "domestic reinvestment plan" for all cash dividends eligible for the deduction. The plan must be approved by the president or chief executive officer before the dividends are paid, and also must be approved by the board of directors. Further, only certain types of expenditures qualify as permitted domestic reinvestment. One category that has generated much discussion is "financial stabilization for the purposes of job retention or creation." A series of floor and hearing statements as well as previously proposed amendments in the Senate could provide a basis for determining whether this phrase should be interpreted to include, for example, debt repayment, pension plan contributions, stock buybacks or shareholder dividends.

There is nothing in the statute that requires the investment to be incremental compared to what the company had invested during prior years or compared to the pre-legislation plans of the company as to the election year. Indeed, Senators Breaux and Feinstein tried to introduce an explicit incremental investment requirement in the prior Senate committee and floor consideration of the provision and their amendment was defeated.

It does not appear that there is any requirement to trace the cash generated by the specified dividends to the investments in the plan. Also, the provision does not specifically address whether the expenditures may be made over a period of years, particularly in the case of capital investments, nor does it specify whether there are any consequences if a reinvestment plan must be altered or terminated in mid-course. The above would suggest that it is preferable to establish a broad plan setting forth as many permitted uses as possible, and with flexibility as to allocation among such uses over a reasonable period of time under the circumstances.

In general, the legislation contains no restrictions on offshore external or internal borrowing by a CFC to fund dividends covering the base period amount or to produce DRD eligible dividends. However, a new provision added by the Conference Committee requires that the taxpayer reduce its cash dividend amount eligible for the deduction by the amount of any increase in overall CFC debt to related parties between October 3, 2004 and the close of the taxpayer’s election year. Although this provision was intended to prevent a roundtrip of cash from the U.S., it raises various technical issues and may require planning to manage certain legitimate and entirely unrelated transactions, such as license arrangements and sales of property that give rise to intercompany payables. Expense Deduction Allocation and Apportionment

In another provision added at the eleventh hour by the Conference Committee, the legislation denies any deduction for expenses "properly allocated and apportioned to the deductible portion" of the cash dividends. On its face, this provision raises a wide variety of issues and could materially reduce the repatriation benefit for many taxpayers. Colloquies on the floor of the House and Senate before final passage of the legislation suggest a narrower, although still somewhat ambiguous, meaning. Senator Grassley stated, for example, that the provision was intended to refer only to "directly related" expenses, and listed stewardship costs and directly related legal and accounting fees as examples of costs that should be "properly allocated and apportioned."

There are also questions about whether the deductible portion of the dividends reduces gross income or results in the exclusion of a portion of asset basis for purposes of allocating and apportioning other expenses, such as R&D and interest expense, under both the gross income and asset methods of sections 861 and 864.

One of the most significant elements of the legislation for planning purposes is the denial of foreign tax credits for the deductible portion of the cash dividends, including any withholding taxes paid in order to repatriate the dividends. In appropriate circumstances, planning opportunities, for example under section 304, may be available to eliminate withholding tax, thereby minimizing the loss of credits on the deductible portion of the dividends.

Under the legislation, there is an issue as to whether there may be an averaging down of high tax earnings with low tax earnings. Taxpayers must cover their base period average amount

before any cash dividends become eligible for the DRD. The Conference Report Statement of Managers states that taxpayers may identify which dividends cover the base period amount and which are treated as in excess of such amount. Logically taxpayers will designate high tax dividends to overcome the base period average amount and low tax earnings for the DRD. One issue is whether such identification could overcome the potential averaging affect that could occur as a dividend is paid through a chain of operating CFCs or through a CFC holding company. Section 956 loans would avoid any dilution, but section 956 inclusions apparently cannot be taken into account in overcoming the base period average. In structures where there is an intermediate holding company which captures the income before any averaging, there would be less of an issue.

The provision may require U.S. shareholders to include in income the section 78 amount allocable to the deductible portion of their cash dividends, notwithstanding that the legislation expressly disallows use of the related foreign tax credits. Although it is not clear that such a result was intended, this interpretation obviously would increase the cost of repatriating under the provision and could determine whether or not it will be beneficial to apply section 965 to a particular pool of earnings.

We note that taxpayers are not able to take advantage of current year losses or carryover NOLs to offset the tax on the non-deductible portion of any dividends.

© 2005 Sutherland Asbill & Brennan LLP. All Rights Reserved.

This article is for informational purposes and is not intended to constitute legal advice.