| Repatriated
Dividends Encouraged Under the American Jobs Creation Act
By
Stewart Berger
JANUARY 2006 - IRC
section 965, created under the American Jobs Creation Act
of 2004 (AJCA), allows U.S. companies to repatriate earnings
from their foreign subsidiaries at a reduced tax rate. IRC
section 965 provides that U.S. companies may elect, for one
taxable year, to receive an 85% deduction for eligible dividends
from their foreign subsidiaries. The election applies to actual
cash dividends, not to any deemed dividends or foreign tax
credit gross-ups. Distributions of previously taxed income,
with certain exceptions, are excluded. The
dividend eligible for the deduction is limited to the greatest
of 1) $500 million; 2) the earnings shown as permanently
invested outside the U.S. on the most recently audited financial
statements certified before July 1, 2003; or 3) in the case
of a financial statement that fails to show a specific earnings
amount but does show a specific tax liability attributable
to such earnings, an amount equal to the tax liability divided
by 0.35 (i.e., the liability is grossed up).
Reinvestment
Required
For
the dividends to qualify for the repatriation dividends-received
deduction (repatriation DRD), they must be invested in the
United States under a properly approved domestic reinvestment
plan [IRC section 965(b)(4)]. Eligible taxpayers can elect
to claim the deduction from either the last tax year that
begins before October 22, 2004, or the first tax year that
begins during the one-year period commencing on October
22, 2004.
The
dividend must be extraordinary. The dividend cannot exceed
the excess of all dividends received during the tax year
from the controlled foreign company over the annual average
for the base period years of 1) dividends received during
each base-period year from the controlled foreign company;
2) amounts included in the U.S. shareholder’s gross
income for each base-period year under IRC section 951(a)(1)(B)
for increases in investments in U.S. property by the controlled
foreign company; and 3) amounts that would have been included
for each base-period year for the controlled foreign company
but for IRC section 959(a) (nontaxable distributions of
previously taxed income). Base-period years are defined
as three of the five most recent tax years ending before
July 1, 2003, excluding the years with the highest and lowest
of actual and deemed distributions. The dividend cannot
be financed by related-party loans.
The
repatriated dividends that are eligible for the reduced
tax rate must be reinvested by the company in the United
States pursuant to a domestic reinvestment plan approved
by the company’s president and CEO as well as approved
by the company’s management committee or board of
directors before the funds are repatriated.
The
plan must describe specific anticipated investments in the
United States as well as a reasonable time period for the
plan’s completion. There is no specific form, but
the plan must state the total dollar amount for each principal
investment. The plan may provide for alternative investments
to be made if the principal investments specified cannot
be made.
Reinvestment
Planning Alternatives
Permitted
investments identified in IRC section 965 include the following:
-
Hiring and training of workers;
-
Infrastructure and capital improvements;
-
Research and development;
-
Financial stabilization for the purpose of U.S. job retention
or creation;
-
Certain acquisitions of business entities with U.S. assets;
-
Advertising and marketing; and
-
Acquisition of rights to intangible property, such as
patent rights.
Expenditures
that are not permitted investments include the following:
-
Executive compensation;
-
Intercompany transactions;
-
Dividends and other shareholder distributions;
-
Stock redemptions;
-
Portfolio investments;
-
Debt instruments; and
-
Tax payments.
The
election to apply the IRC section 965 repatriation provision
is made by attaching Form 8895 to the tax return for the
year timely filed. Information must be reported to the IRS
annually regarding investments made under a domestic reinvestment
plan.
Before
enactment of the AJCA, a company could deduct up to 100%
of the dividends received as a special deduction under IRC
section 243 or 245. With the enactment of the AJCA, IRC
section 965(c)(4) states that if an election is made for
a DRD, then no deduction is allowed under IRC sections 243
or 245. The DRD under IRC section 965 is taken as an expense
to arrive at taxable income.
The
new repatriation DRD provides significant planning opportunities
for U.S. companies with interests in controlled foreign
companies. Because the election is elective and reduces
foreign tax credit eligibility, advance planning will be
beneficial in order to determine the best course of action
to take. As new law, the AJCA is open to interpretation
until the IRS has issued technical corrections.
Stewart
Berger, CPA, is a tax manager at Rosen Seymour Schapps
Martin & Company LLP, New York, N.Y.
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