Congress Considers Repeat of Tax Repatriation Holiday

Congress Considers Repeat of Tax Repatriation Holiday

Congress is looking at a House bill that would revive the dividends received deduction of IRC Section 965 and provide U.S. corporations with operations abroad a tax break on repatriated profits for 2011 or 2012. (See  Lexis Tax Advisor -- Federal Code § 965(a)).

The bill was introduced by Representative Kevin Brady, a Texas Republican, and co-sponsored by three Democrats and two fellow Republicans, and the bill appears to be generating further bipartisan interest, or at least further discussion. (See "U.S. Lawmakers Introduce Repatriation Tax Break Bill," Worldwide Tax Daily (TaxAnalysts®, May 13, 2011); and "Tax-Repatriation Holiday Gathers Some Steam," The Wall Street Journal Online, Kristina Peterson (June 23, 2011)). Treasury, however, appears cool to the idea.

In 2004, a tax holiday for repatriated profits of U.S. corporations was granted by way of the enactment of IRC Section 965. The general rule of IRC Section 965(a) provides that "[i]n the case of corporation which is a United States shareholder and for which the election under [IRC Section 965] is in effect for the taxable year, there shall be allowed as a deduction an amount equal to 85 percent of the cash dividends which are received during such taxable year by such shareholder from controlled foreign corporations."  (See Lexis Tax Advisor -- Federal Code § 965(a)).

The effect of the 85 percent dividends received deduction under IRC Section 965(a) is a reduced tax rate of 5.25 percent, which is a significant reduction from the top corporate tax rate of 35 percent. (See Lexis Tax Advisor -- Federal Code § 965(a) and "Tax-Repatriation Holiday Gathers Some Steam," The Wall Street Journal Online, Kristina Peterson (June 23, 2011)).

The 2004 provision was enacted to encourage U.S. corporations with shares in controlled foreign corporations to bring the profits from these controlled foreign corporations to the United States in view of this significant deduction. (See Lexis Tax Advisor -- Federal Code § 965(a)). The current provision has the same goal.

 H.R. 1834, the Freedom to Invest Act of 2011, amends IRC Section 965 to provide for a temporary dividends received deduction for the years 2011 and 2012. (Under the 2004 temporary dividends received deduction, taxpayers also had a limited time to take advantage of the deduction). (See Lexis Tax Advisor -- Federal Code § 965(f); H.R. 1834, which is available at "H.R. 1834 Would Allow Temporary Dividends Received Deduction," Tax Notes Today, TaxAnalysts® (May 12, 2011), or at the U.S. Government Printing Office website). H.R. 1834 would amend IRC Section 965(f) to provide that the taxpayer may elect to apply IRC Section 965 to: "(1) the taxpayer's last taxable year which begins before the date of the enactment of this subsection, or (2) the taxpayer's first taxable year which begins during the 1-year period beginning on such date." (See H.R. 1834, available at "H.R. 1834 Would Allow Temporary Dividends Received Deduction," Tax Notes Today, TaxAnalysts® (May 12, 2011)).

As noted in articles in the Wall Street Journal and Tax Analysts' Worldwide Tax Daily, critics of the current proposal contend that the 2004 tax holiday did little, if anything, in the way of boosting the economy at home and in creating jobs. (See "U.S. Lawmakers Introduce Repatriation Tax Break Bill," Worldwide Tax Daily (TaxAnalysts®, May 13, 2011)); and "Tax Holiday Rejected on Overseas Profits", The Wall Street Journal, John D. McKinnon (March 24, 2011); and "Tax-Repatriation Holiday Gathers Some Steam," The Wall Street Journal Online, Kristina Peterson (June 23, 2011)).

In addition, citing a report by the Joint Committee on Taxation, Representative Lloyd Doggett (D-Tex.) has noted that a repatriation tax holiday would result in the Treasury losing nearly $80 billion in tax revenue over the next decade. See "Doggett Cites JCT on High Cost of Repatriated Earnings Tax Holiday," Tax Notes Today, TaxAnalysts® (May 12, 2011).

One notable difference between the 2004 tax holiday for repatriated profits and the current tax holiday is that under H.R. 1834, there is a reduction in the amount of the allowable deduction if a corporation taking the deduction does not maintain certain employment levels. H.R. 1834 would amend IRC Section 965(b)(4) to provide in paragraph (A) that:

"If, during the period consisting of the calendar month in which the taxpayer first receives a distribution described in subsection (a)(1) and the succeeding 23 calendar months, the taxpayer does not maintain an average employment level at least equal to the taxpayer's prior average employment, an additional amount equal to $ 25,000 multiplied by the number of employees by which the taxpayer's average employment level during such period falls below the prior average employment (but not exceeding the aggregate amount allowed as a deduction pursuant to subsection (a)(1)) shall be taken into income by the taxpayer during the taxable year that includes the final day of such period." (See H.R. 1834, available at "H.R. 1834 Would Allow Temporary Dividends Received Deduction," Tax Notes Today, TaxAnalysts® (May 12, 2011)).

Under the current version of IRC Section 965(b)(4), the amount of the dividends received deduction is not tied to the taxpayer's employment levels. The current version provides, in part, that the deduction in IRC Section 965(a) shall not apply to any dividend received by a U.S. shareholder unless the amount of the dividend is invested in the U.S. pursuant to a domestic reinvestment plan that met certain relatively general requirements. (See Lexis Tax Advisor -- Federal Code § 965(b)).

Another change to IRC Section 965 proposed in H.R. 1834 is the amendment of the language of (b)(1) pertaining to limitations on the amount of the allowable deduction. Currently, IRC Section 965(b)(1) provides in part that the amount of dividends taken into account under Section 965(a) shall not  exceed the greater of:

(A) $ 500,000,000;
(B) the amount shown on the applicable financial statement as earnings permanently reinvested outside the U.S.; or
(C) in the case of an applicable financial statement that fails to show a specific amount of earnings permanently reinvested outside the U.S. and that shows a specific amount of tax liability attributable to such earnings, the amount equal to the amount of such liability divided by 0.35. (See IRC Section 965(b)(1)).

H.R. 1834 would amend IRC Section 965(b)(1) by eliminating the $500 million limitation amount and the language referencing an applicable financial statement. As amended, IRC Section 965(b)(1) would read as follows:

"The amount of dividends taken into account under subsection (a) shall not exceed the sum of the current and accumulated earnings and profits described in section 959(c)(3) for the year a deduction is claimed under subsection (a), without diminution by reason of any distributions made during the election year, for all controlled foreign corporations of the United States shareholder." (See H.R. 1834, available at "H.R. 1834 Would Allow Temporary Dividends Received Deduction," Tax Notes Today, TaxAnalysts® (May 12, 2011)).

As noted above, the administration has signaled that it would not support a tax holiday for repatriated profits unless the reprieve was part of a comprehensive tax reform proposal. (See "U.S. Lawmakers Introduce Repatriation Tax Break Bill," Worldwide Tax Daily (TaxAnalysts®, May 13, 2011), and "Tax Holiday Rejected on Overseas Profits", The Wall Street Journal, John D. McKinnon (March 24, 2011)). Thus, the prospects for a temporary tax holiday are somewhat in doubt, considering the difficulty of passing any sort of comprehensive tax reform legislation. Nonetheless, interest in the measure continues, as indicated by efforts in Congress to tweak it, such as requiring the repatriated profits to be used by corporations in job creation. See "House Democrats Frown on Repatriation Use Restrictions," Tax Notes Today, TaxAnalysts® (June 16, 2011). As Congress and the White House currently meet on the debt ceiling and related spending cuts and tax increases, I think it is unlikely that the temporary dividends received deduction and a big tax break for corporations will be a part of the discussion, but it is a proposal worth watching when the attention turns to comprehensive tax reform.

RELATED LINKS: For further guidance on the dividends received deduction, please see:

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