It seems that tax reform is unceasing; every election cycle brings calls for “fairness” by supporters of all political parties with the definition of fairness seeming to be that, “I pay too much - and you don’t pay your fair share.” Each year brings additions to, or changes in, the laws we live under, many of which have an impact on the Internal Revenue Code as lawmakers seek “fairness.” A truly cynical view to be sure, but the news seems to reinforce this perception on a daily basis. One particular viewpoint does seem likely though: if there is to be major tax reform in 2017, a tax on the repatriation of foreign earnings by U.S. corporations appears to be a cornerstone in the construction of any proposed new law that is being offered by the administration or Congress.
While U.S.-based corporations (both privately owned and multinational publically held) are supposed to pay income taxes on worldwide income, they are generally permitted under the law to defer tax on earnings of foreign subsidiaries until the earnings are repatriated as dividends to U.S.-based parents. By following current tax rules, it’s possible to hold these deferred earnings outside the U.S. indefinitely.
It is estimated U.S. corporations hold in excess of $2.5 trillion of corporate earnings outside the U.S. In theory, if this full amount was repatriated at once, Washington would see a one-time sizeable expansion of tax revenue while the U.S. economy would hopefully benefit from the remainder through additional investment by corporations into plant and equipment, and through hiring. However, how much of these earnings are being held in cash and how much have been reinvested in property, plant, equipment to continue on-going foreign operations is unknown.
Because of the differences, there are calls for multiple tax rates on the deferred foreign earnings that would be brought into income under a new tax regime. For example, some proposals call for a rate of 8.75% on cash or cash equivalents versus a rate of 3.5% on other types of investments. Further, this potential one-time repatriation toll-charge that would be enacted would likely be coupled with a change in U.S. tax law that either expands rules against the future ability to defer income from tax in a worldwide tax U.S. tax system or shifts the U.S. tax system to a territorial system that exempts foreign sourced income from tax in some manner (a topic for another time).
What appears to be a simple rule on the surface, based upon the dual rate proposal above for example, becomes more difficult as one dives into the murky details; every tax law change brings its own complexities and as opportunities for potential maneuvering are identified. Cash equivalents will need to be defined, and rules may need to be implemented that prevent companies from shifting investments into non-cash equivalents to be able to utilize a lower rate. Companies in different industries, but with the same amount of deferred earnings, may have different tax results because of the business requirements, whether inherent in the business operations by their nature or by foreign regulation of an industry. For example, the investment by a steel manufacturer in property, plant and equipment is quite different than that of a bank with liquidity requirements.
In summary, the state of current tax proposals is not complete, the passage of any law is uncertain in today’s political environment, and a company’s need to continue to plan and stay abreast of the potential impact on its earnings and taxes at it relates to repatriation is ongoing.