Tax Break Opportunity

Companies can save on taxes by repatriating foreign income.

While many large U.S. corporations reportedly plan to take advantage of a limited-time window to bring home billions of dollars in foreign earnings in exchange for a tax break, experts say other companies should also consider the opportunity.

A provision in the 2004 American Jobs Creation Act (AJCA) gives C corporations a one-year window to "repatriate" income earned overseas and reinvest it in the United States at an effective tax rate of 5.25 percent—considerably less than the usual corporate tax rate of 35 percent. To qualify for the break, companies must provide a written plan on how they will reinvest their tax savings in the United States by, for example, hiring and training new employees.

Short Window of Opportunity
When it comes to international tax and treasury management, many U.S. companies traditionally have not repatriated earnings from offshore subsidiaries operating in low-tax jurisdictions. Instead, they've opted to reinvest foreign earnings in those subsidiaries, using the higher after-tax earnings and deferring the full U.S. corporate tax rate until repatriating the money at a later date. As a result, many of these businesses have built up foreign-retained earnings and cash on their balance sheets—even while carrying record levels of debt. The repatriation provision of the AJCA gives them a new, if temporary, incentive to bring the money back home.

A key issue for executives to consider is how the repatriation benefit aligns with their company's fiscal year. Under the law, shareholders of controlled foreign subsidiaries can choose one taxable year to claim a deduction equal to 85 percent of certain extraordinary dividends received from the corporation's foreign earnings. However, that benefit must be taken either during the parent company's taxable year that includes October 21, 2004, or the first taxable year beginning after that date. For most companies, that means the tax deduction can be claimed for the 2004 or 2005 tax year.

Complex Calculations
When the AJCA's repatriation incentive was first signed into law last October, many potential beneficiaries sat on the sidelines awaiting clarification from regulators. While the U.S. Treasury Department did provide guidance on the law this spring, calculating the advantages and pitfalls of repatriating foreign earnings involves complex financial transactions that may require specialized expertise.

For example, earnings must be repatriated as cash dividends. Therefore, a company may need to fund the difference between the desired repatriation amount and cash on hand in overseas subsidiaries. That could require financing solutions that enable companies to convert foreign earnings into cash that can be repatriated.

In addition, the earnings must be repatriated in U.S. dollars. Because many offshore subsidiaries operate in local currencies, repatriation may result in significant foreign-exchange issues. Companies may need to pursue hedging strategies to lock in favorable exchange rates for foreign-currency balances being repatriated.

On the other hand, the Treasury Department indicated that repatriated funds are "fungible," meaning companies do not have to trace or segregate the origin of the money. Instead, a participating business needs only to demonstrate that the total amount of repatriated funds has been placed in a domestic reinvestment plan.

Creating the Plan
The reinvestment plan, a key component of the AJCA, requires a company to specify how it will invest repatriated funds in the United States to create or protect the jobs of U.S. workers. While the law requires a company's executive management to present a plan in advance of repatriation, it allows the company's board of directors to grant approval after receipt of the dividend.

The AJCA gives companies wide latitude in determining how to use repatriated funds for job creation and retention. According to a white paper published online by the Association for Financial Professionals, permitted activities include:

•    Worker training and hiring
•    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 percent ownership interest in another business entity to the extent the business entity's assets constitute qualifying investments
•    Funding capital investments or financial stabilization for the purpose of job retention or creation, including debt repayment
•    Funding qualified benefit-plan obligations
•    Funding product liability or environmental claims

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

Not for Everyone
While saving 85 percent on corporate income taxes for repatriated foreign earnings might seem like a no-brainer, it's not for every company. General Electric, for example, has $14 billion in eligible foreign earnings but has publicly said that it will bring little of it home, preferring instead to invest that money in emerging markets. Xerox announced that it sees no "material benefit" from the incentive and is unlikely to repatriate any of its foreign earnings.

By carefully evaluating the financial picture of your company's foreign operations or subsidiaries, you can make good decisions on whether repatriation is a sound strategy for your company.

Reprinted with permission from RSM McGladrey Advantage. For more information, visit www.rsmmcgladrey.com/advantage or call Kristin Wing at (816) 751-1813.