January 3, 2005 -- A temporary incentive has been provided to multinational organizations to encourage them to repatriate profits they have earned overseas and reinvest them here in the U.S.   Under the current law, Congress believed such profits would otherwise remain abroad and decided to provide an incentive to repatriate.

Generally, earnings of a U.S. controlled group of corporations that are from foreign subsidiary operations conducted by controlled foreign corporations (CFC) are only subject to U.S. income tax when the earnings are distributed as a dividend to a U.S. corporation.  Until distributed, the U.S. income tax on such earnings is generally deferred.  There are certain exceptions that accelerate such taxation. A foreign tax credit is generally available to offset, in whole or in part, the U.S. tax owed on foreign-source income recognized which has also been taxed by a foreign jurisdiction.

The 2004 Jobs Act provides for a one-time 85%-dividends-received deduction for cash dividends received by a U.S. corporate shareholder from a subsidiary that is a CFC.  The deduction is allowed as elected by the U.S. shareholder during one of the two tax years.

The term “ U.S. shareholder” is defined for this purpose as a U.S. person who owns at least 10% of CFC’s voting power.  The new law makes no change in this definition.

At the election of the taxpayer, the new dividends received deduction applies for:

• the taxpayer’s last tax year that begins before date of enactment, OR
• the taxpayer’s first tax year that begins during the one-year period beginning on date of enactment.

The election must be made before the due date (including extensions) for filing the tax return for that year.

Some of the specifics of the 85% deduction include:

• Only cash dividends received during the election year qualify, including such as cash amounts treated as dividends under Code Sec. 304 (the deduction does not apply to items that are not included in gross income as dividends, such as subpart F inclusions or deemed repatriations under Code Sec. 956).
• The only foreign tax credits that may be used to reduce the tax on the nondeductible portion of the dividend are those attributable to such nondeductible portion.
• Foreign tax credits are not allowed on the deductible portion of the dividend (and such taxes do not give rise to Section 78 gross-up amounts).
• The repatriated cash must be reinvested under a “domestic reinvestment plan.”  There is broad discretion allowed as to the goals of such a plan; only executive compensation is explicitly excluded.  Thus, the repatriated cash can be used for the purchase of infrastructure, research and development, capital investments, or the financial stabilization of the corporation for the purposes of job retention or creation (which would appear to include debt reduction, the strengthening of balance sheets, share buybacks and acquisitions).
• The amount of dividends taken into account in computing the new deduction generally can’t exceed the greater of $500 million or the amount held outside the U.S.
• This applies only to “extraordinary” dividends, measured by excess repatriations over the taxpayer’s average repatriation level over three of five most recent tax years.
• There is prohibition against funding such dividends with additional related party debt (for example, direct or indirect loans of the U.S. parent).  All CFCs with  respect to which the taxpayer is a U.S. shareholder are treated as one CFC for purposes of the related party debt rules, and thus, indebtedness between such CFCs is disregarded for purposes of this determination.
• No deduction is allowed for any tax for which no credit is allowable under this rule.
• The taxpayer may specifically identify which dividends are treated as carrying the new dividends received deduction and which are not; if not so identified, a pro rata amount of foreign tax credits is disallowed with respect to every dividend received during the tax year.
• Also, the 15% includible portion of the dividend may not be offset by net operating losses.
• The tax on the nondeductible CFC dividends cannot be offset by tax credits (other than foreign tax credits and AMT credits).
• The new deduction is not treated as a preference item for purposes of computing the AMT .

Tax payers should consider a myriad of issues related to their business operations and current and future tax planning prior to making any election under this new law. 

For more information, contact Bill Burns at 215-564-1900 . 

Back to News Archive