RSM Resources

While many large U.S. corporations reportedly planto take advantage of a limited-time window to bring home billions of dollars inforeign earnings in exchange for a tax break, experts say midsized companiesshould also consider the opportunity.

A provision in the 2004 American Jobs Creation Act(AJCA) gives C corporations a one-year window to "repatriate" incomeearned overseas and reinvest it in the United States at an effective taxrate of 5.25 percent — considerably less than the usual corporate tax rate of35 percent. To qualify for the break, companies must provide a written plan onhow they will reinvest their tax savings in the United States by, for example,hiring and training new employees.

"The [repatriation] proposal initially wasbacked primarily by larger companies," said Dorothy Coleman, vicepresident of tax policy for the National Association of Manufacturers in Washington, D.C."But more and more companies are focusing on it, because they realize itcould be very helpful to them."

While repatriation presents an opportunity for U.S. companiesto shift foreign assets back home without significant tax consequences,estimates vary widely on how much money that represents. The bipartisan JointCommittee on Taxation projects repatriated income at about $150 billion, whilesurveys of corporate executives by New York-based JPMorgan Chase put the totalas high as $425 billion. That means the U.S. Treasury could gain anywhere from$8 billion to $22 billion in corporate income tax revenue it otherwise mightnot have collected.

Lawmakers supported repatriation to boost domesticbusiness investment and stem the outflow of U.S. jobs abroad. Using JPMorgan’sdata, Decision Economics Inc. of New York estimated that the repatriation measure couldboost U.S. Gross Domestic Product (GDP) by 0.8 percentage points in 2005 andcreate up to 880,000 extra jobs this year and next. The Decision Economicsstudy, released before passage of the AJCA, was sponsored by the Washington,D.C.-based American Council for Capital Formation, a lobbying grouprepresenting business interests.

Short window of opportunity

When it comes to international tax and treasurymanagement, many midsized U.S.companies traditionally have not repatriated earnings from offshoresubsidiaries operating in low-tax jurisdictions. Instead, they’ve opted toreinvest foreign earnings in those subsidiaries, using the higher after-taxearnings 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 ontheir balance sheets — even while carrying record levels of debt. Therepatriation provision of the AJCA gives them a new, if temporary, incentive tobring the money back home.

A key issue for executives to consider is how therepatriation benefit aligns with their company’s fiscal year. Under the law,shareholders of controlled foreign subsidiaries can choose one taxable year toclaim a deduction equal to 85 percent of certain extraordinary dividendsreceived from the corporation’s foreign earnings. However, that benefit must betaken 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 firstsigned into law last October, many potential beneficiaries sat on the sidelinesawaiting clarification from regulators. While the U.S. Treasury Department didprovide guidance on the law this spring, calculating the advantages andpitfalls of repatriating foreign earnings involves complex financialtransactions that may require specialized expertise.

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

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

On the other hand, the Treasury Departmentindicated that repatriated funds are "fungible," meaning companies donot have to trace or segregate the origin of the money. Instead, aparticipating business needs only to demonstrate that the total amount ofrepatriated funds has been placed in a domestic reinvestment plan.

Creating the plan

The reinvestment plan, a key component of theAJCA, requires a company to specify how it will invest repatriated funds in theUnited States to create orprotect the jobs of U.S.workers. While the law requires a company’s executive management to present aplan in advance of repatriation, it allows the company’s board of directors togrant approval after receipt of the dividend.

The AJCA gives companies wide latitude indetermining how to use repatriated funds for job creation and retention.According to a white paper published online by the Association forFinancial 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 taxesfor repatriated foreign earnings might seem like a no-brainer, it’s not forevery company. General Electric, for example, has $14 billion in eligibleforeign earnings but has publicly said that it will bring little of it home,preferring instead to invest that money in emerging markets. Xerox announcedthat it sees no "material benefit" from the incentive and is unlikelyto repatriate any of its foreign earnings.

Those choices by major companies, says DorothyColeman, demonstrate the level of care midsized company executives must take toevaluate whether repatriation is worth the extra effort.

"There are some hurdles you have to gothrough to bring [the funds] back in," she says. "Depending on acompany’s particular circumstances, it might not be worth it."

By carefully evaluating the financial picture ofyour company’s foreign operations or subsidiaries, you can make good decisionson whether repatriation is a sound strategy for your company.