Repatriated Dividends Encouraged Under the American Jobs Creation Act

By Stewart Berger

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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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