Autumn is traditionally the time for watching a football game, enjoying the World Series and enjoying seasonal color changes. This fall, fiery orange and yellow colors over Washington, D.C., may be more the foliage changing.
On Oct. 11, 2011, the U.S. Senate’s Committee on Homeland Security and Governmental Affairs Permanent Subcommittee On Investigations, chaired by U.S. Sen. Carl Levin, issued its Majority Staff Report entitled “Repatriating Offshore Funds: 2004 Windfall for Select Multinationals.” The timing is interesting as there is discussion of whether some version of a repatriation tax holiday should be considered in 2011 or 2012 to assist in creating some stimulus for employment growth.
For purposes of background, in 2004, the America Jobs Creation Act was enacted. The AJCA permitted U.S. corporations to repatriate qualified earnings held outside the United States at an effective federal corporate tax rate of 5.25 percent instead of the top 35 percent corporate income tax rate. The stated purpose of this tax provision was to encourage companies to return cash assets to the United States, which proponents of the provision argued would spur increased domestic investment and U.S. jobs.
Under the provisions in the ACJA, 85 percent of the qualified dividends repatriated were excluded from the regular federal corporation tax rate of 35 percent. This resulted in an effective federal corporate tax rate of 5.25 percent on the cash repatriations for the 2004/2005 period for which the tax provision was effective.
As expected, the enactment spurred the repatriation of offshore cash. In 2008, the Internal Revenue Service reported that 843 companies took advantage of the provision and repatriated approximately $312 billion in qualified dividends under the provisions of the repatriation tax holiday (Section 965 of the Internal Revenue Code). The original budget projections were $235 billion.
The Oct. 11 report is based on analysis obtained by the committee staff in which they surveyed 20 multinationals, and of that survey group, 15 made repatriations. The 15 corporations reportedly repatriated more than $150 billion, or nearly half of the total of the more than 800 corporations that made repatriations.
The report indicates that from 2004 through 2007, these corporations reduced their work forces and increased research and development expenditures (though at a lower rate than before the repatriations). It also notes in the findings of fact that company stock repurchases increased after the repatriations, as did executive compensation.
The findings also note that funds were repatriated from tax havens, and that more than $2 trillion in cash assets is now held in the U.S. This fact is noted in the report perhaps to make the point on whether the current stated rationale for another repatriation tax holiday is necessary.
The report notes that half the repatriations were from pharmaceutical and technology companies. Just looking at the charts and figures in the report, six pharmaceutical companies repatriated $88 billion of qualified earnings under the incentive.
The “tax havens” listed include some traditional country names as well as the Netherlands and Ireland. Some may question whether the Netherlands or Ireland are “tax havens,” as the term can be very subjective and inflammatory. The report noted that one U.S. company repatriated all of its funds from its Irish subsidiary, which had no employees. Then, the discussion notes the same Irish subsidiary has four operating subsidiaries with 500 employees. The report didn’t comment that it is very common for multinational companies to use a holding company in the jurisdictions where they have operations with active subsidiaries.
Reviewing the information in the IRS 2008 report, it indicates that the countries where dividends were paid under the repatriation holiday include 450 companies that were either from Canada or the United Kingdom. So roughly half of the companies that received dividends were not from tax havens but were from two of the U.S.’s largest trading partners.
Granted, some of the findings in the report are interesting, but they are made based on information from 20 companies, when more than 800 actually participated in using the provisions of the favorable tax treatment. Yes, the companies surveyed are perhaps the largest beneficiaries of the repatriation tax holiday, but some of the findings may not be transferable to all or a majority of the 843 companies that claimed benefits under the incentive.
The debate for how to tax offshore earnings is a discussion that should be had. Certainly, the economic and policy reasons for any reparation holiday also need to be analyzed and carefully considered in the context of tax, fiscal and economic policy.
The issue of repatriation does impact tax revenue in the current environment. The fact of the matter is that if the companies don’t repatriate, no U.S. tax revenue is generated. If they do repatriate, it does generate tax revenue as well as brings cash back to the U.S. Even if used for share repurchases, the selling shareholders still need to reinvest the proceeds. The repatriation tax holiday provided for in 2004/2005 actually raised revenue and exceeded revenue estimates. Some have suggested that more specific criteria for the use of funds may assist in the investment and employment growth goals that many in Washington desire to achieve.
Tax policy and tax reform are likely to get more attention as the weeks draw near. Taxes are surely going to be part of any discussions on deficit and debt reduction. Many in business and in Washington make the point that tax competitiveness needs to be included in the debate with respect to any major tax reform discussion.
The U.S. federal corporate tax rate was last reduced as part of the Tax Reform Act of 1986, when it was reduced from 46 percent. After that reduction, the U.S. had one of the lowest corporate tax rates in the industrialized world. In the past 10 years or so, most nations have reduced their marginal rates below the U.S. federal corporate income tax rate. In fact, Canada and the U.K. are in staged reductions bringing their respective tax rates into the mid-20s. These rates, when fully in force, are at a rate that approximates only 65 percent of the current U.S. federal corporate income tax rate. Both the U.K. and Canada have a tax structure that generally does not tax offshore earnings from treaty partner country operations.
Some economists and political pundits argue that in a world of managing competitive pressures, including labor, material and tax costs, a large tax rate differential is likely not a positive marketing tool for attracting certain investment and economic activity to the U.S.
It is perhaps not the perfect time for the consideration of the 9-9-9 proposal that is getting some discussion on the campaign trail, but it may be an opportunity for some out-of-the-box thinking that helps examine where we are and where we need to go with tax policy.
William Roth is a tax partner with the local office of BDO USA LLP. The views expressed are those of the author and not necessarily of BDO. The comments are general in nature and are not to be considered specific tax or accounting advice.