Bringing it home: summary and analysis of the repatriation provision of the American Jobs Creation Act.

• Author: Stoffregen, Philip A.

New section 965 of the Internal Revenue Code, added by the American Jobs Creation Act of 2004, offers U.S. multinational corporations a unique one-time opportunity to repatriate low-taxed foreign earnings at an incremental U.S. tax cost as low as 5.25 percent. The new provision, however, is extremely complex, and key definitions are ambiguous and difficult to apply. With the issuance of Notice 2005-10 on January 13, 2005, the Department of the Treasury has taken the first step toward alleviating the uncertainty created by the statute. Notice 2005-10 refines the definition of "cash dividends," and provides guidance concerning the dividend reinvestment plan and the kinds of investments in the United States for which repatriated funds may be used. Future guidance will address the foreign tax credit and expense allocation, rules for adjusting the base period amount to account for mergers, acquisitions and spin-offs, and rules regarding controlled groups. In view of the importance of section 965, Congress is already considering technical corrections to the statute.

As a practical matter, for financial statement purposes, every multinational that has reported a material amount of unrepatriated foreign earnings as indefinitely reinvested outside the United States under APB 23 will be determining whether and to what extent it intends to repatriate these earnings under section 965. Fortunately, a recent FASB Staff Position allows a grace period for making this determination.

This article summarizes new section 965 as supplemented by Notice 2005-10, and attempts to clarify issues that remain ambiguous under the statute. Finally, practical suggestions are offered for navigating through the decision to repatriate and for taking full advantage of the available benefit.

1. Summary of Legislation

   1. Purpose

      Section 965 is one of several significant international tax reforms included in the American Jobs Creation Act of 2004 (the Jobs Act). The purpose of the Jobs Act is "To amend the Internal Revenue Code of 1986 to remove impediments in such Code and make our manufacturing, service, and high-technology businesses and workers more competitive and productive both at home and abroad." (1) Section 965 was intended to encourage U.S. corporations to repatriate foreign subsidiary earnings for use in strengthening their domestic businesses and creating new jobs in the United States.

   2. History of Provision

      Section 965 was introduced by House Ways and Means Committee Chair William Thomas, (R-CA), on July 25, 2003, as part of H.R. 2896, the American Jobs Creation Act of 2003. (2) A revised version was reintroduced as part of H.R. 4520, the American Jobs Creation Act of 2004, on June 4, 2004. (3) The House approved the bill on June 17, 2004.

      The Senate version of the bill, S. 1637, was introduced by Senate Finance Committee Chair Charles Grassley (R-IA) and Senator Max Baucus (DMT), on September 18, 2003. It was passed by the full Senate on May 11, 2004. The Senate version of the bill contained some notable differences from the House bill. Rather than an 85-percent dividends-received deduction, it would have achieved the reduction in tax by replacing the normal tax on repatriated earnings with a 5.25-percent excise tax. The provision limiting the eligible dividend to the greater of $500 million or the amount shown as permanently reinvested outside the United States on the corporation's applicable financial statement was included in the House bill, but not the Senate version. In addition, although both versions contained the requirement for a dividend reinvestment plan, only the Senate version identified five non-exclusive "permissible uses."

      A conference agreement was reached on October 6, 2004, generally following the House bill, with modifications. The Jobs Act, including new section 965, was signed into law by President Bush on October 22, 2004. (4) On November 19, 2004, the House and the Senate each introduced a Technical Corrections bill proposing amendments to the Jobs Act, including clarifications of a number of issues related to section 965. (5)

   3. Summary of Section 965

      New section 965 permits a U.S. shareholder to elect a one-time 85-percent dividends-received deduction for cash dividends received from controlled foreign corporations (CFCs). (6) The provision offers a one-time reprieve from U.S. taxation on repatriated earnings, but it is bounded by a number of limitations to ensure that the overall goal of the statute is met. Congress intended the provision as an incentive for the repatriation of foreign earnings that would otherwise remain offshore. Thus, eligible dividends must be "extraordinary"--that is, in excess of the average annual amount paid over a three-year base period. There is an overall ceiling on eligible dividends of the greater of $500 million or the amount shown as permanently reinvested outside of the United States on the U.S. shareholder's applicable financial statement. Most important, the deduction is only available for dividends earmarked for reinvestment in the United States in ways that will strengthen the competitiveness and productivity of the U.S. business.

   4. Timing Considerations

      A taxpayer may choose to make the election for the last tax year beginning before the date of enactment of the section (October 22, 2004), or for the first taxable year beginning after that date. For a calendar year taxpayer, the election is therefore available for either the 2004 or 2005 tax year. The election is made on Form 8895, which must be filed before the due date, including extensions, for filing the return. (7)

   5. Common Fact Patterns Where Section 965 May Be Beneficial

      Section 965 may be beneficial to a U.S. multinational in a number of situations. The most basic is where the U.S. shareholder's controlled foreign corporations have substantial low-taxed unrepatriated foreign earnings. Absent section 965, the U.S. tax on a payment of these earnings in the form of a dividend to the U.S. shareholder would not be fully offset by the section 902 deemed-paid foreign tax credit, and U.S. tax would be imposed to bring the combined foreign and U.S. tax liability to 35 percent. Section 965 may also be advantageous to U.S. multinationals that are unable to utilize foreign tax credits because of net operating losses or an overall foreign loss. Section 965 may also facilitate the unwinding of structures in which a U.S. company is "sandwiched" between a foreign parent and a foreign subsidiary, by providing a tax efficient way to reduce the value of CFCs owned by the "sandwiched" U.S. corporation. (8)

2. Determining Whether to Repatriate Under Section 965

   1. How Much Can Be Repatriated Under Section 965?

      1. Greater of $500 million or APB 23 Amount. The maximum amount that may be treated as an eligible dividend under section 965 is the greater of $500 million or the amount shown as earnings permanently reinvested outside the United States on the applicable financial statement. The term "applicable financial statement" means the U.S. shareholder's most recently audited financial statement that is certified on or before June 30, 2003, as being prepared in accordance with generally accepted accounting principles. In the case of a taxpayer required to file a financial statement with the Securities and Exchange Commission, the term means such statement filed on or before June 30, 2003. If the applicable financial statement does not state the amount of earnings permanently reinvested outside the United States but shows the tax liability on such earnings, then the amount of permanently reinvested earnings is computed by dividing the tax liability by 0.35. (9) If no applicable financial statement exists, or if it does not show an amount permanently reinvested outside the United States or the correlative tax liability, the maximum amount of the eligible dividend is $500 million.

         For many companies, the amount repatriated under section 965 will be limited by the $500 million ceiling. Certain companies, however, have financial statements showing an amount permanently reinvested outside of the United States greatly in excess of $500 million, with a handful in the $10 to $20 billion range. It has been estimated that the total earnings eligible for repatriation is approximately $750 billion, and that up to $300 billion will actually be repatriated under section 965. (10)

         In applying section 965, all U.S. shareholders that are members of an affiliated group filing a consolidated return are to be treated as one U.S. shareholder. (11) All corporations treated as a single employer under section 52(a) are limited to one $500 million ceiling, and the $500 million is to be allocated among those corporations under regulations to be prescribed. (12) If an applicable financial statement applies to more than one U.S. shareholder, the amount shown as permanently reinvested outside the United States (or the tax liability associated with such earnings) is to be divided among all U.S. shareholders under regulations to be prescribed. (13)

      2. What Qualifies as a Cash Dividend? The term "cash dividends" includes distributions from non-previously taxed earnings and profits of a first-tier CFC. It also includes distributions that are excluded from taxable income as previously taxed income (PTI) under section 959(a) if they are attributable to a dividend "up the chain" from a lower-tier CFC that caused a subpart F inclusion under section 951(a)(1)(A) in the year of the election.

         The definition of "cash dividends" is expansive enough to cover certain amounts received under Code sections that recharacterize amounts as dividends. The focus is on whether the U.S. shareholder actually receives cash and whether the cash comes from one or more CFCs (in contrast to a third party). Thus, cash received in a redemption that is treated as a dividend under section 302 or 304 does qualify. (14) Notice 2005-10 provides the additional clarification that boot...