Foreign Tax Break Results in Huge Windfall

Hundreds of U.S. companies collectively gained $265 billion from a law allowing a one-time deduction on dividends from foreign companies they contr...
Stephen TaubJune 20, 2008

A 2004 law designed to encourage U.S. multinational companies to invest repatriated foreign earnings was “extremely successful,” according to a new analysis by Grant Thornton.

The accounting firm says newly available IRS data reveals that the one-time dividend deduction offered under the American Jobs Creation Act of 2004 provided 843 corporations with deductions totaling $265 billion. Those corporations repatriated a total of $312 billion in qualified dividends. The $265 billion in deductions amounted to almost one-third of the total accumulated nontaxable earnings of all controlled foreign corporations (CFCs) for tax year 2004, according to Grant Thornton.

The American Jobs Creation Act allowed corporations to deduct 85 percent of the qualifying dividends received from foreign corporations they controlled. Foreign earnings are generally not taxed until they are repatriated, but can be taxed as high as the top corporate rate of 35 percent when paid as dividends to U.S. corporations.

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The deduction was subject to several restrictions and limitations, and required that the extraordinary dividends qualifying for the deduction be reinvested in domestic activities. One of the permitted activities was creating new jobs in the United States; at the time, economists at JPMorgan Chase predicted that the tax holiday could yield as many as 600,000 new jobs. The report, however, does not quantify how many new jobs were created as a result of the act.

Companies were not permitted to spend the cash on such items as dividends, share buybacks, or executive compensation.

Nearly 10,000 U.S. corporations had CFCs in 2004, but just 843 took advantage of the deduction, according to Grant Thornton.

“Even though just a small percentage of companies took advantage of the one-time deduction, it was extremely successful in prompting the repatriation of vast sums of foreign profits,” says Joseph Calianno, international tax technical practice leader at Grant Thornton. “It was a particularly effective means for U.S. corporations with CFCs in low-tax jurisdictions to repatriate earnings without a high U.S. tax cost.”

Grant Thornton explains that corporations with earnings in high-tax jurisdictions are often able to use foreign tax credits to reduce U.S. taxes on repatriated income, but companies with CFCs in low-tax jurisdictions have less incentive to bring profits home.

According to the report, more than 60 percent of the dividends qualifying for the one-time deduction were repatriated from Europe, with 26 percent coming from CFCs incorporated in the Netherlands. Almost 10 percent came from companies in Bermuda and 5.5 percent from Cayman Islands firms.

Manufacturing companies were much more likely to take advantage of the provision: they accounted for more than 80 percent of the dividends that qualified for the deduction. Pharmaceutical manufacturers alone accounted for more than 30 percent of the qualifying dividends, with just 29 corporations claiming an average deduction of almost $3 billion.

Grant Thornton, meanwhile, expects Congress to consider a similar program in the near future. It adds, “The amount of money repatriated matched the most ambitious estimates and dwarfed the expectations of Congress’s official scorekeeper, the Joint Committee on Taxation.”