Tax Reform and the Repatriation of Foreign Earnings
“To be or not to be?” – that is the question facing many tax reform proposals currently before Congress.
Amid this uncertainty, there is an idea that has support from both sides of the aisle – enacting a one-time deemed repatriation of foreign earnings and taxing such earnings at a reduced rate.
When foreign earnings are distributed to the United States, the current system offers a credit for income taxes paid abroad, but imposes an additional tax to ensure the total tax liability of the U.S. company sums to 35 percent (the highest corporate tax rate among developed countries). This residual U.S. tax discourages companies from bringing money back home.
President Trump has proposed a one-time deemed repatriation of foreign earnings subject to a 10 percent tax payable over a 10-year period. Under Trump’s tax plan, future foreign earnings would be subject to U.S. tax on a current basis because deferral rules would be repealed.
Under the House of Representatives’ “Better Way” plan, Congressional Republicans have proposed a one-time deemed repatriation of foreign earnings subject to an 8.75 percent tax for cash/cash equivalents and a 3.5 percent tax for other assets. This tax would be payable over an 8-year period. Under the House GOP plan, future foreign earnings would not be subject to tax because the United States would adopt a territorial tax system.
In 2015, Senator Chuck Schumer (D-New York) and Senator Rob Portman (R-Ohio), co-chairs of the Senate Finance Committee working group on international tax reform, also outlined a plan for a one-time deemed repatriation of overseas income and a transition to a territorial-like system. Their plan was similar to President Obama’s 2015 budget proposal, which would have levied a 14 percent tax on foreign earnings through a one-time deemed repatriation of funds.
Note that the one-time deemed repatriation of funds included under these proposals differs from the tax holiday provided by Congress under the American Jobs Creation Act (AJCA) of 2004. At that time, Congress approved a temporary dividend repatriation provision that allowed U.S. companies to repatriate funds at a 5.25 percent tax rate. The idea was that companies would voluntarily bring money home to create new jobs and stimulate new businesses.
However, without other reform measures that reduce the incentive to shift profits abroad over the long-term, an optional repatriation tax is a revenue loser. This is because there is nothing to prevent firms from stockpiling funds overseas again in anticipation of the next tax holiday.
In 2011, a Senate subcommittee report found that most of the cash that was earmarked for new jobs under AJCA’s voluntary repatriation provision was instead used for stock buybacks and executive compensation. The report notes that $312 billion of qualified repatriation funds were remitted to the United States, but research and development expenditures did not accelerate, and U.S. jobs were lost rather than gained. The report concludes that the arrangement cost the United States $3.3 billion in forgone tax revenue.
According to the Joint Committee on Taxation, the amount of undistributed foreign earnings in U.S. companies totals $2.6 trillion. These earnings remain exempt. Imposing a minimum tax on these undistributed earnings, while implementing other provisions that discourage shifting profits abroad, would make the provision a revenue raiser over the 10-year budget window. This revenue could help President Trump fund his proposed infrastructure spending on highways, bridges and airports.
Funding infrastructure spending makes the proposal attractive to Congressional Democrats, but Congressional Republicans have suggested such revenue would be used to cover rate cuts instead. While there may not be consensus on how the revenue would be spent, there appears to be bipartisan support for levying a minimum tax on foreign profits currently parked offshore.
ABOUT THE AUTHOR
Tara Fisher is an adjunct professor at the University of Pittsburgh Katz Graduate School of Business. Tara is also an independent tax consultant and her professional experience includes working for the United States Congress, Joint Committee on Taxation, and the national tax practice of Pricewaterhouse Coopers. Tara is a Certified Public Accountant and holds a Master of Science in Accounting from the University of Virginia.