The June 22, 2011 edition of the Salisbury Post printed an opinion from Jim Rogers, CEO of Duke Energy, titled “Let’s repatriate overseas profits”. The article discusses corporate profits “trapped” overseas, and how that money can be brought back to the U.S. to help rebuild the economy.
What is meant by “repatriation”? Corporations with earnings from foreign subsidiaries must pay income taxes on that profit to the foreign host country. On the corporation’s U.S. tax return, income from all sources is taxed, but a foreign tax credit is allowed for taxes paid to a foreign country, so the same income isn’t taxed twice. When foreign income that has not yet been taxed by the U.S. is brought back to the United States, or “repatriated”, tax on that income is then due at the current corporate rate of 35%. So in theory, at the end of the day, the corporation pays 35% tax (and no more) on earnings of all operations, foreign and domestic.
As Mr. Rodgers states, the U.S. corporate tax rate is the second highest in the world. Multi-national companies go to great lengths to “offshore” as much profit as possible. Google, for example, is reported as saving $3.1B in taxes through the use of sophisticated tax shelters called the “Double Irish” and the “Dutch Sandwich”, which involves foreign subsidiaries In Ireland, the Netherlands and Bermuda.
The proposal, creatively named the Freedom to Invest Act and contained in H.R. 1834, would “refresh” IRC Section 965 to temporarily provide a 5.25% tax on earnings distributed by a controlled foreign subsidiary to its U.S. parent, rather than the normal 35% rate – essentially a “tax holiday” for repatriated corporate earnings. The bill is sponsored by Rep. Brady of Texas and 10 others, including Sue Myrick, and has been endorsed by Sen. Hagan.
The use of foreign subsidiaries can dramatically lower effective tax rates. The problem is in returning those profits to the U.S. so they can be spent in the U.S. Current U.S. repatriation law negates any deferred tax rate gains, so the corporate goal becomes repatriation at minimal tax cost. Currently, most tax-minimizing repatriation shelters are based on IRC Section 368(a)(2) which governs tax-free reorganizations of corporations. For example, the “Killer B transaction”, so named because it is based on Section 368(a)(2)(B), is a cross-border triangular reorganization that has the effect of repatriating foreign earnings of a subsidiary to the parent corporation without a corresponding dividend to the parent that would be subject to U.S. income tax. The “Deadly D”, named for IRC Section 368(a)(2)(D), is another repatriation strategy involving a reorganization that allows one U.S. company to transfer to a foreign subsidiary the assets of another acquired U.S. company, enabling the foreign subsidiary to kick offshore cash back to the U.S. company parent without incurring repatriation taxes. “Outbound F”, is another reorganization-based shelter.
The temporary repatriation “tax holiday” was created in 2004 to entice corporations to repatriate foreign earnings. Reasons given by multi-national corporations to repatriate in 2004 are the same as now, to altruistically boost the economy. Sen. Hagan said “A repatriation holiday can encourage economic activity at a fraction of the cost of fiscal policy”. Jim Rogers states “At a time when our country’s economy needs a shot in the arm and our federal government can no longer afford stimulus funds, American businesses stand ready to step up and inject $1 trillion trapped overseas by punitive federal tax law” and “We need congressional action now to unlock this cash so it can be put to work here at home to spur our economic recovery in the U.S.”
Similar arguments were made during the last repatriation holiday in 2004, called the Homeland Investment Act. So how did that work out? According to a study released by the National Bureau of Economic Research, "Repatriations did not lead to an increase in domestic investment, employment or R&D, even for the firms that lobbied for the tax holiday stating these intentions”. An estimated $300B was repatriated, of which 92% was used for share buybacks and corporate acquisitions.
Michael Mudaca, the assistant secretary for tax policy at the Treasury Department, stated “In 2004, when the U.S. enacted a repatriation holiday, the goal was to encourage U.S. multi-nationals to pay bigger cash dividends from their overseas subsidiaries and use the cash to make investments in the United States. Unfortunately, there is no evidence that it increased U.S. investments or jobs, and it cost taxpayers billions”.
An example is Dell, which promised to use the money to build a new plant in Winston-Salem. They repatriated $4B in 2004, and spent $100M on the plant (which they later acknowledged they would have built anyway), then used $2B for a share buyback. By the way, Dell also obtained $7M in local incentives to open the Winston-Salem plant, and subsequently halted production there in 2010.
Repatriated earnings of Pharmaceutical companies in 2004 went mostly towards acquisitions of other companies.
An estimated $100B of repatriations was never “trapped” offshore in the first place. Corporations, aware of the impending enactment of the 2004 Act, off-shored profits of U.S. operations into foreign subsidiaries, then “round-tripped” them back at the reduced rate.
Repatriated profits go straight to the bottom line of the corporation’s earnings at a bargain tax burden, and would provide a nice bump in profitability and resulting share prices. Although Congress is trying to provide penalties if job loss occurs within a 2 year window, the actual amount of the penalty is around $8,700 per employee, hardly enough to dissuade layoffs. Based on what the corporations actually did in 2004, rather than what they said then and now, it is likely that job creation and capital investment resulting from repatriation now would be insignificant, and the cost to the taxpayer would be the total amount repatriated multiplied by 35% minus 5.25%.
Don’t be deceived. This idea is driven by corporate greed, not corporate concern for the U.S. economy. Multi-nationals have gone to great expense to shelter the earnings at issue from U.S. tax. Denying repatriation merely puts them on a level playing field with domestic-only companies. Their earnings are “trapped” overseas by their own design and intent.
The real problem is the corporate tax rate. To compete in a global economy, we should truly simplify the tax code and lower the top rates.