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August 31, 2011
Effects of 2004 Int'l Tax Holiday, Recommendations Going Forward

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By M. Mendel Pinson

M. Mendel Pinson completed his MBA at Columbia Graduate School of Business in May, and has joined Scientific Games Corp., a leading supplier of game content and technology to the lottery and gaming industries. Before business school, he worked in investment banking and in the retail and consumer industry. Melanie Shanley completed her MBA at Columbia in May and will join McKinsey & Co. in its New York office in the fall. Before business school, Shanley worked in investment banking and in the entertainment industry.

The authors argue that the American Jobs Creation Act of 2004 failed to create jobs in the United States. However, in this critical economic period, taking a longer term perspective on the treatment of foreign earnings could have a lasting effect and meet the goals of the Jobs Act.


In late 2004 Congress enacted the American Jobs Creation Act of 2004 (Jobs Act, P.L. 108-357), enabling U.S. firms to repatriate foreign profits at a reduced tax rate for one year. Despite the clear regulatory restriction on the use of those funds, empirical research suggests most of the repatriated funds were distributed to U.S. shareholders. While critics point to that as evidence that the 2004 tax holiday was a failure from a reinvestment perspective, it was clearly a successful revenue event for the treasury, as it collected corporate taxes on presumably "shielded" profits. Also, the IRS collected capital gains taxes from shareholders who sold in the share repurchase programs.

As the U.S. struggles with unprecedented fiscal deficits, the debate on taxing foreign profits has resurfaced. Republicans advocate a new tax holiday while the Obama administration fiercely opposes the concept, proposing instead to tax foreign profits even when not repatriated. While it has some benefits, President Obama's proposal is unlikely to gain traction in the current Congress, as many will point to the long-term negative economic effects that plan would have now that U.S. corporations' growth is increasingly generated abroad.

As we will show, current U.S. policy on taxing foreign earnings distorts firm behavior by incentivizing reinvestment abroad or hoarding foreign earnings in low-tax countries, rather than investing profits in the area that provides the most growth opportunities. That creates a disadvantage to investment in domestic operations, as well as robs shareholders of the growth opportunities that firms would pursue if their decision-making were not distorted by tax policy. Further, introducing a new repatriation tax holiday to stimulate growth and reinvestment in the United States would not only fail to produce the desired effects, but would further exacerbate the distortion in decision-making by creating an expectation among U.S. firms that those holidays would be a somewhat regular occurrence and encouraging them to hoard cash abroad in anticipation of another tax holiday.

Thus, we propose that the solution is not to introduce a new tax holiday, nor to tax all foreign earnings at the current domestic rate regardless of repatriation. Instead, we propose enacting longer-term reforms that would create a separate, internationally competitive tax rate on foreign earnings in order to level the playing field and remove the value-destroying incentives driving corporate decisions on the reinvestment of foreign earnings. That could potentially lead to greater value creation for shareholders, smarter investment by firms, and a new source of revenue for the federal government.

Overview of the 2004 Jobs Act

Section 965, enacted as part of the Jobs Act in October 2004, provides for a one-year dividend repatriation tax holiday. Section 965 allows a U.S. corporate shareholder (USS) to elect, for one tax year, to receive an 85 percent dividends received deduction (DRD) on qualifying dividends received from its controlled foreign corporations. That allowance would generally reduce the effective tax rate on repatriated earnings to 5.25 percent.1 The USS could elect to take the holiday either in the tax year immediately preceding or following enactment of the law -- effectively, 2004 or 2005 for U.S. corporations ending their tax year on December 31. Qualifying dividends, as described in section 965, were initially subject to four principal limitations, later clarified in three notices from the IRS2:

    1. Section 965(b)(1) caps the amount of the dividend eligible for the DRD. The amount eligible was deemed to be the greater of $500 million or "the amount shown on the applicable financial statements as permanently invested outside the U.S." Section 965(b)(2) limited the DRD to "extraordinary" cash dividends: those demonstrated to be in excess of the average dividends paid to the U.S. corporation by the CFC. Thus, only dividends that exceeded a base period amount found by taking the average of dividends and other distributions during the five years ending on June 30, 2003 could qualify.

    2. Section 965(b)(3) reduced the amount of the eligible dividend by any increase in related-party debt. Because the dividend had to be paid in cash and cash equivalent securities could not be used, any debt issued to the CFC from the USS, or any increase in debt of the CFC for which the U.S. corporation was deemed to be principally liable, was deducted from the amount eligible for the dividend. In effect, the CFC would have to take on debt, liquidate cash equivalent securities, or use cash on hand to pay the extraordinary dividend. The USS could not take on debt to fund its own dividend. The increase in debt would be measured by finding the difference in intraparty debt on the first measurement date -- October 3, 2004 -- and the last measurement date -- the last day of the election year.3

    3. Finally, section 965(b)(4) created the most controversial and flexible limitation in the dividends qualifying for the DRD. This stipulation required that the USS claiming the DRD invest the full amount of the dividend in the United States, in accordance with a domestic reinvestment plan (DRIP) adopted before the payment or the dividend. The DRIP was required to be approved by the management of the USS, including the CEO and the board of directors, making it subject to Sarbanes-Oxley requirements.4

Because of the broad nature of the initial requirement under section 965(b)(4), the IRS issued a notice to clarify the level of specificity expected of the plan, as well as qualifying and non-qualifying investments. The full amount of the dividend was clarified to include not just the cash received, but also the pretax amount received, unreduced either by the taxes paid on the nondeductible portion or the foreign withholding taxes. For example, if a USS received a dividend of $100,000 that qualifies under section 965 for the DRD and pays taxes on the nondeductible amount of $15,000, in addition to $10,000 in foreign withholding taxes, the USS must reinvest the complete amount of $100,000, even though it will receive only $90,000 in cash before U.S. taxes are assessed.5 The level of specificity required in the description of how those funds would be spent indicated only that the total amount spent on each permitted investment be stated and an estimated reasonable time frame for completion of the investment given.

However, no incremental investment requirement was imposed under the limitation. Specifically, the USS could use the funds for any qualifying investment without having to demonstrate that the amount spent on that investment exceeded either (1) the average amount spent in previous years, or (2) the amount of spending budgeted before receiving the dividend. Further, the timing of the reinvestment was flexible, with no deadline imposed, and a safe harbor stipulation that released the USS from liability if it invested 60 percent of the planned amount within two years of receiving the dividend. And finally, there was no tracing requirement. Thus, given that cash is fungible, any amount of existing cash could be moved from permissible investments to nonpermissible investments and replaced with the cash from the qualifying dividend.

Finally, permitted and non-permitted investments were made explicit in Notice 2005-10.6 However, the permitted investments were sufficiently broad as to provide only a small number of excluded uses of the dividend. Those excluded uses were the payment of executive compensation, and "a USS group's payment to its shareholders of dividends, for return of capital, or in the redemption of stock,"7 thus specifically excluding share repurchases. The permitted uses of the dividend, however, included such broad categories as "financial stabilization" of the USS, compensation to existing employees, worker hiring and training, infrastructure and capital investment, advertising and marketing, acquisition of intangible property, payments to contractors within the United States, pension funding, and anything deemed to reduce the "financial constraints" on the USS group's U.S. operations.8 That range of permissible investments, then, made it quite simple for a USS group to meet its reinvestment requirement without adjusting its corporate strategy.

Success and Effects of the Act

Of the roughly 9,700 companies that had CFCs in 2004, 843 corporations took advantage of the DRD, repatriating $362 billion, of which $312 billion was eligible for deduction.9 By some estimates, Congress had expected $400 billion in cash to be repatriated under section 965, so on that measure the bill achieved its purpose. However, the stated goal of the Jobs Act and of section 965 was to provide economic stimulus in the United States and to promote the creation of new jobs. Congressional representatives from both parties made the case for the bill based on the jobs that would be created with new cash investments by domestic companies:

    Multiple Studies show my repatriation provision could bring $400 billion back into our economy and create upward of 600,000 jobs in America in 2005, while reducing the deficit by $163 billion.10

    Today more than at any time in our history, we operate in a global economy. This vote for the Jobs Act is about fixing our international tax law and providing much needed tax relief for businesses to help create jobs.11

    This bill provides tax relief for American businesses to further fuel economic growth and job creation.12

Thus, to analyze the effects of the bill based on those relatively transparent metrics -- the stimulation of growth and investment among participating companies and the resulting job creation -- seems like an appropriate measure of success. However, we will also look at some of the unintended consequences of the bill, both negative and positive.

The companies that chose to take advantage of section 965 and repatriate earnings in excess of their baseline averages were overwhelmingly large, multinational companies. The average total year-end assets of participating firms was more than $24 billion, and the average amount repatriated was roughly $429 million.13 Those firms were predominantly in mature industries, such as manufacturing, which made up 68 percent of repatriating firms; service companies, which made up 12 percent; or retail, which accounted for 6 percent.14 Not surprisingly, large firms with profitable foreign subsidiaries are often mature themselves, and hence have limited growth investment opportunities. For the repatriation of foreign earnings to lead to economic stimulus and job creation, the participating companies must have growth opportunities in which they can responsibly invest; it has been shown that the reduced cost of the investment attributable to the tax break will not incentivize firms to invest in unattractive opportunities. Further, the fungible nature of cash makes it possible for firms to use it for restricted purposes while still meeting the reinvestment requirement. Clearly, it was not cash constraint that was preventing the firms from making growth investments, it was the lack of attractive opportunities.

By using several proxies for growth and comparing multinational firms that chose to repatriate with those that did not take advantage of the act, Roy Clemons and Michael R. Kinney have shown that firms that chose not to repatriate had more growth investment opportunities in the United States and invested more in growth in the years following the holiday.15 It also has been shown that there was no statistically significant increase in spending in research and development, capital expenditures, and acquisitions among the repatriating firms. The only statistically significant increase in spending by those firms was in share repurchases, suggesting the repatriated funds merely replaced funds that had already been allocated for investment, and that those funds, now freed up, were returned to shareholders.16

A study of the effects of section 965 estimates that repatriating firms increased share repurchases by $60 billion more than non-repatriating firms, and demonstrates that that disparity cannot be explained by increases in earnings. The amount spent on share repurchases by the repatriating firms represents roughly 20 percent of all funds repatriated.17 3M, which repatriated $1.7 billion under section 965, increased its stock repurchases to about $2.4 billion in the 12 months ending June 2005, compared with roughly $1.5 billion in repurchases in the year prior. And Starwood Hotels & Resorts openly stated that while they intended to comply with the letter of the law, they would not comply with the spirit; the company announced a $1 billion stock repurchase plan on the same day they announced they would repatriate $550 million under the Jobs Act.18

               Table 1. Aggregate Repatriation Amounts and Growth
                    in Permanently Reinvested Earnings (PRE)
                             (dollars in billions)

                             Growth in PRE    Reptriations      Growth in PRE
 Industry                    1998-2003 ($)    Under Act ($)     2006-2008 ($)

 Food, beverage, and            15.45            22.89            22.22
 tobacco manufacturing

 Wood product and paper          8.25             6.50             4.04

 Petroleum, coal products,     108.71           123.52           126.93
 and chemical manufacturing

 Computer and electronic        36.80            52.39            61.58
 equipment manufacturing

 Machinery, equipment,
 and miscellaneous              11.15            14.64            23.07

 Software and                    9.63             7.44            17.39

 Finance and insurance          16.20            14.38            31.51

 Accomodations, food, other      9.02             4.75            42.44

 Total                         215.21           246.51           329.18

 Source: Thomas J. Brennan, "What Happens After a Holiday?"
 Northwestern Journal of Law and Social Policy.

Another unintended effect of the passage of section 965 was the increase in the amount and rate of growth of foreign earnings permanently reinvested abroad. When Congress passed the Jobs Act, it warned that the tax holiday was a one-time event and should not be repeated, as doing so would encourage multinationals to keep earnings overseas in anticipation of future tax holidays, reducing real-time incentives to invest in jobs and growth in the United States.19 In fact, that anticipated effect has come to pass, as the permanently reinvested earnings (PRE) maintained abroad by companies that participated in the repatriation holiday has now likely grown to exceed the amount repatriated under the act, as shown in Table 1 above, based on a sampling of participating companies across several industries. Growth in accumulated PRE for specific repatriating companies before and after repatriation under the Jobs Act is also shown in the far right columns of Table 2. The current tax policy, which in essence punishes companies for repatriating earnings, and the expectation of periodic relief from that policy, has created a kind of moral hazard, unintentionally disincentivizing domestic investment.

Finally, the prevalence of layoffs at repatriating companies, while only observable on an anecdotal level, also suggests that the repatriation tax holiday did not necessarily save jobs that had become redundant or were eliminated for strategic reasons. As shown in Table 2, many of the large multinational firms that repatriated well above the average amount of cash also had significant layoffs in the years following the tax holiday. Again, regardless of the tax incentive, management of those firms could not be persuaded to make investments or spend cash in a manner that was not within their corporate strategy or in the best interest of shareholders.

However, the act did have some positive consequences, and among those was the generation of $16.4 billion in revenue for the U.S. treasury. Some critics focus on the $128 billion in tax revenue that would have been raised had the same earnings been repatriated without the enactment of the tax holiday, but that is only chimera. As the growth in PRE during the years before and after the holiday suggests, it is likely that none of those extraordinary dividends would have been paid to the USS group companies, and thus the forgone revenue to the treasury would have been zero.20

     Table 2. Selected Information on 12 Corporations That Used Section 965
                             (dollars in billions)

                                                    Pre-AJCA        Post-AJCA
                   Repatriations    Jobs Lost in   Accumulated     Accumulated
 Company            Under AJCA      2005-2006          PRE*            PRE*

 Pfizer                 37             10,000           67             101

 CitiGroup             3.2                N/A            9            35.8

 Merck                15.9              7,000           33            29.7

 Hewlett-Packard      14.5             14,500         28.9            23.7

 Proctor & Gamble     10.7           Unspecified      24.7              54

 IBM                   9.5                N/A         34.7              33

 PepsiCo               7.5                250         16.3            25.5

 Motorola              4.4           Unspecified      13.7             8.1

 Honeywell             2.7               2,000         5.5               7

 Ford                  0.9          30,000-40,000      N/A             N/A

 National              0.5             5 percent       N/A             N/A
 Semiconductor                       of workforce

 Colgate-Palmolive     0.8              4,000          N/A             N/A

 Source: Marples, Donald; Jane Gravelle, "Tax Cuts on Repatriation
 Earnings as Economic Stimulus: An Economic Analysis," Congressional Research
 Service, Jan. 30, 2009.

 *Permanently reinvented earnings.

Case Study: Ford Motor Co.

Although it is likely that a lack of cash constraint made it unnecessary for U.S. companies to use the repatriated funds for growth investment during the period of the tax holiday, it is possible that the holiday helped to relieve cash constraints in the following years. Ford Motor Co. was able to repatriate $900 million during the holiday, and though layoffs followed, that may have been an unavoidable strategic move. But the extra cash on hand may have allowed the company to remain the only one of the Big Three U.S. automakers who did not require or request a bailout from the government during the recent financial crisis. In fact, the cash may have given Ford the flexibility to invest in domestic operations and avoid additional job eliminations.21

Related IRC Rules on Shareholder Distributions

Foreign profits repatriation is rooted in the U.S. tax system. Specifically, corporations are incentivized to leave and reinvest profits abroad because of two key policies of the "classical" tax regime. The first relates to double taxation in general and the second to the way foreign profits are taxed in the United States. The code requires corporations to distribute after-tax earnings to its shareholders, which are then taxed at the personal level. If the shareholder of a U.S. entity is a corporation, section 243 states that a DRD could be taken if the dividend recipient owns at least 10 percent of the distributing entity. The deduction could be up to 100 percent of the dividend received if the corporation owns at least 80 percent of the subsidiary's stock.

In the case of a foreign subsidiary, section 902 states that the U.S. parent reports the entire pretax distributed amount and pays U.S. corporate income taxes on that amount, offset by whatever taxes were already paid to the foreign government. For example, X is a U.S. corporation that has a wholly owned subsidiary, Y, domiciled in Ireland. Y generated $100 of pretax profits and was taxed at 12.5 percent. It then distributes all its after-tax earnings ($87.50) to X. X will recognize $100 of income, which will be taxed at 35 percent (ignoring state and local taxes), or $35, but will receive a $12.50 credit for taxes already paid in Ireland. In other words, it will end up with $65 after taxes, exactly the same amount it would have if the profits were earned in the United States.

The second tax rule that discourages repatriation of foreign profits relates to residency. The United States is one of the few countries in the world that taxes its citizens on earnings they generate outside their home country. U.S. corporations are considered individual citizens for that purpose and are taxed in the same manner. However, a foreign entity -- defined by its country of domicile and incorporation -- is not taxed in the United States, even if it is wholly-owned by a U.S. individual or corporation. Therefore, it is very easy for U.S. corporations to avoid paying taxes on their foreign profits by simply incorporating a subsidiary in a more tax-friendly country. Foreign profits will be taxed in the United States only when realized by the domestic parent, which occurs either through the sale of its stock or the receipt of a dividend payment. Thus, U.S. corporations pay a heavy price for repatriating foreign funds and would do so only if absolutely needed.

That distortion is further accentuated in terms of reinvestment opportunities. Let us take the previous example with a U.S. corporation, X, and its Irish subsidiary, Y. Both are presented with distinct investment opportunities in their respective countries. As before, Y has $87.50 available in cash from accumulated earnings while X does not have any excess cash. From an economic perspective, X should choose the investment that will generate the highest internal rate of return (IRR). However, it would need to take into account the incremental taxes for which it would be liable if funds were repatriated to the United States. Specifically, assume each country presents identical investments with 15 percent IRRs. Y could invest its $87.50, receive $101 in one year, be taxed at 12.5 percent on the appreciation and end up with $99. In contrast, X will only have $65 to invest in the United States after taxes, which will yield $75 pretax and $71 after tax. To yield the same $99 after tax, X will need more than 80 percent in pretax IRR compared with Y's 15 percent. This example clearly illustrates the difficulty for U.S. corporations to justify repatriation of foreign funds unless absolutely needed.

That U.S. investment disadvantage is presumably what lawmakers had in mind when they passed the Jobs Act in 2004. Taxes on repatriated funds were reduced to as low as 5.25 percent but on the condition that they be invested in domestic growth projects. Critics point to no evidence of reinvestment by repatriating firms but rather to high correlations of share repurchases, arguably because the Jobs Act reduced the one-time tax but not the rate at which future profits from the domestic investment will be taxed. Going back to our example, the act increased the initial U.S. investment to $82 from $65 -- a significant improvement; however, at 15 percent pretax return, net proceeds will be $90 after one year, still substantially lower than Ireland's $98. Indeed, the U.S. investment would still require more than double Ireland's pretax IRR (31 percent versus 15 percent) to yield the same proceeds. That is another reason why U.S. corporations repatriated huge amounts of cash during the tax holiday but did not invest it in domestic growth opportunities. In other words, the repatriation issue is deeply rooted in the U.S. tax code and domestic corporate tax rate.

Debate Over a New Tax Holiday

The fragile economic and fiscal condition of the United States has reignited the debate on the soundness of a tax holiday on foreign profits. Economic growth remains anemic while unemployment stays uncomfortably high. As a result, the treasury has seen its revenue erode while outlays have soared to unprecedented levels because of astronomical bailouts and increased welfare transfers. With U.S. firms estimated to be holding more than $1 trillion in untaxed cash abroad, foreign profits have resurfaced as a potential partial rescue for both economic and fiscal emergencies.

Both advocates and opponents of a new tax holiday point to the Jobs Act's results. Supporters focus on the more than $300 billion that was repatriated and the $16 billion in new tax revenue it generated. While some argue that $16 billion is low compared with what could have been collected at full tax rates, advocates counter that the IRS would see none of it as foreign profits showed no sign of coming home pre-holiday.

Critics focus on the intended reinvestment benefits or, rather, the lack thereof. They point to the many studies (mentioned above) that show little evidence of reinvestment activities by repatriating companies and strong evidence of share buybacks by those corporations. Essentially, they claim that the main purpose of the act was to spur investment and job creation and that none of that was achieved. Although investment was a legal requirement to qualify for the deduction, companies were able to circumvent it because of two key details in the guidance. First, there was no requirement to directly trace the repatriated funds to an investment project and, second, there was no time limit on when that reinvestment needed to occur. All a firm needed to do was submit a DRIP and spend the stated amounts. Therefore, most corporations could fund their reinvestment plans over time from cash from operations or other sources and immediately distribute the repatriated funds to shareholders. Because of those shortcomings in section 965, opponents claim there is little reason to believe a reenactment will trigger different results.

Another argument against the initiation of a short-term tax holiday at this time is that cash availability does not appear to be the primary constraint on U.S. firms investing domestically. In fact, U.S. firms are hoarding even more cash domestically than they are currently holding abroad (an estimated $2 trillion or more).22 That is the largest pool of cash that has been available in domestic firms in more than 50 years. Thus, allowing them to bring back more cash would not spur investment; clearly, anemic domestic investments from U.S. firms is a result of limited attractive investment opportunities, not cash constraints. A short-term tax holiday would thus create similar results to the first holiday, and most likely incentivize returns to shareholders, rather than reinvestment.

An additional claim against a new tax holiday is its long-term effect economically and fiscally. The Jobs Act was enacted to encourage repatriation of funds that would otherwise stay abroad. Therefore, the act restricted the deduction to earnings that were classified as permanently invested abroad. Profits not classified as such did not qualify for the deduction. While that provision ensured that the treasury did not forfeit revenue otherwise collected, it also had the perverse effect of encouraging companies to classify future earnings as permanently invested abroad so as to be able to take advantage of the next tax holiday. Indeed, evidence shows that cash in foreign subsidiaries has soared to close to $1 trillion since the last tax holiday.23 In other words, while the act added a quick $16 billion to the treasury's coffers, it also gave corporations every reason to perpetuate the practice of hoarding cash abroad. Consequently, untaxed cash piles up in foreign countries, spurring the government to enact a new tax holiday to capture at least a portion of the lost tax revenue. And the vicious cycle will only intensify.

Recommendations for Tax Policy Reform

There are several incentives for U.S. corporations to keep cash in their foreign subsidiaries. First, most developed and developing countries tax corporate profits at lower rates than the United States, creating a general advantage to invest in foreign countries in the first place. Second, the United States follows a worldwide tax system that taxes U.S. entities on income earned outside the country, but income earned by a foreign subsidiary is taxed only when distributed to the U.S. parent. By definition, that encourages U.S. corporations to refrain from distributions for as long as possible. Third, those inherent disadvantages to investment of foreign earnings within the United States, as well as the expectation created by the tax holiday that the opportunities to repatriate funds at a lower tax rate will occur in the future, has incentivized companies to hold funds overseas, increasing the disadvantage to the United States.

The first two reasons are more likely the root cause, while the third one is an inevitable but exasperating consequence. Ideally, the foreign funds problem would be permanently resolved by eliminating the distortions that cause it in the first place. The preferred solution would be to lower the U.S. tax rate to compete more aggressively with international standards. Under that regime, the United States could perpetuate its worldwide tax system, although it would be largely irrelevant if corporations continue to get credit for foreign taxes incurred, which they should. Alternatively, the United States could keep its high corporate tax rate but switch to a territorial tax system in which profits earned in foreign territories are not taxed at home. While that would solve part of the problem, one would expect corporations to still favor foreign investments, as they would incur lower taxes on returns from reinvested proceeds because of the lower local tax rate relative to the United States. Nevertheless, the United States is unlikely to so radically overhaul its tax system in the current political gridlock.

Still, the government could reintroduce some version of a temporary tax break on foreign earnings. The new tax holiday should be designed to encourage U.S. investment, provide tax revenue to the treasury, and serve as an experiment for a longer-term solution. That could be achieved by a two-tier tax credit system. The first tier would allow U.S. corporations to enjoy a low tax rate on repatriated funds similar to the Jobs Act with two major differences: The tax rate would be higher (closer to 10 percent subject to sensitivity studies), and there would be no restrictions on use of funds. The second tier would provide corporations with a full tax credit for the 10 percent paid if they reinvest the monies in specific qualifying areas within a specific time frame and under a clear "before/after" test. Further, all future earnings streams from that specific investment would qualify for lower tax rates. The structure needs to be further refined according to research that would optimize various levels and restrict abuses but should be designed to achieve the following:

    1. U.S. reinvestment. Firms could choose to reinvest any portion of the repatriated funds with a strong incentive to reinvest as much as possible. While some firms might elect to incur the full 10 percent tax rate and distribute all repatriated funds to shareholders, it is likely that most firms would capitalize on the opportunity and reinvest. In fact, the exact level of the first-tier tax rate and subsequent credits should be closely studied to provide the best incentive mix to the largest audience.

    2. Marginal tax revenue. At the same time, it is very unlikely that all firms would reinvest every repatriated penny. Rather, as in 2005, we could expect a large amount of shareholder distributions, which would be subject to the first-tier levy as well as personal taxes in the form of dividend or capital gains. Here again, the exact levels should be targeted to result in a blended 5 percent tax rate on all repatriated funds, as that seems to have worked in 2004.

    3. Training ground for long-term solution. All details of the plan need to be designed ex ante and examined ex post in a manner that would provide insight to create a viable and sustainable resolution to the issue. In particular, tax credits for the initial reinvestment and on the recurring earnings stream from that investment will clearly indicate whether a lower tax rate is enough to close the gap between advantages that foreign investments enjoy relative to the United States. If a pattern emerges from those specific investments, a number of conclusions could be drawn and serve as arguments for or against a complete overhaul of the U.S. corporate tax system.


A tax holiday at this point would best serve as a testing period for a long-term overhaul of the U.S. taxation of foreign earnings. In the long term, however, a more competitive and consistent tax policy on foreign earnings must be adopted for U.S. firms to make investment decisions free of artificial incentives. The U.S. system encourages hoarding cash abroad, and thus it withholds funds from even those firms that might reinvest them domestically by unduly penalizing them for repatriation. A more competitive tax rate on foreign earnings would promote the free flow of capital across borders and allow firms to invest where they see opportunity, rather than where the tax incentives are best. Because the current policy disadvantages investment in the United States, the immediate effect would have to be an increased flow of capital into the United States. That would create value immediately, either via investment or via return of cash to shareholders, who can use it to consume and create demand, can invest it elsewhere, and will be required to pay tax on dividend or capital gains income and create revenue for the treasury. Further, under the current system, the treasury is denied needed revenues because the system demands payment of the full corporate tax rate on foreign earnings, and thus the money is never repatriated. That is not a positive result for any U.S. stakeholder and is particularly troubling when considering our growing deficits. Given the growing portion of revenue earned by U.S. firms abroad, an overhaul of our policy on taxing foreign earnings is required to put both our domestic economy and our multinational companies on an even footing with foreign competitors.


1 Deloitte Tax LLP/CFO Research Services, "The Broad Implications of Section 965 Repatriation" (Sept. 2005).

2 IRS, "IRC 965 Dividend Repatriation Audit Guidelines," LMSB-0808-043 (Aug. 27, 2008), Doc 2011-16107, 2011 TNT 143-47.

3 Alan S. Lederman and Bobbe Hirsh, "The Service's Guidelines for Enjoying the Section 965 Foreign Earnings Tax Holiday," 103 J. Tax'n 208 (2005).

4 Deloitte, supra note 1.

5 965 guidelines, supra note 2.

6 2005-1 C.B. 474, Doc 2005-887, 2005 TNT 10-6.

7 See Lederman and Hirsh, supra note 3.

8 Lederman and Hirsh, supra note 3.

9 Melissa Redmiles, "The One-Time Received Dividend Deduction," 27 Statistics of Income Bulletin 102 (2008).

10 House Ways and Means Committee member Phil English, R-Pa., who drafted the bill. See Roy Clemons and Michael R. Kinney, "An Analysis of the Tax Holiday for Repatriation Under the Jobs Act," Tax Notes, Aug. 25, 2008, p. 759, Doc 2008-17694, or 2008 TNT 166-21.

11 Rep. David Wu, D-Ore. See Clemons and Kinney, supra note 10.

12 Rep. Jo Bonner, R-Ala. See Clemons and Kinney, supra note 10.

13 Redmiles, supra note 9.

14 Clemons and Kinney, supra note 10.

15 Id.

16 Id.

17 Jennifer Blouin and Linda Krull, "Bringing it Home: A Study of the Incentives Surrounding the Repatriation of Foreign Earnings Under the American Jobs Creation Act of 2004" (May 2009).

18 Clemons and Kinney, supra note 10.

19 Chye-Ching Huang, "Proposed Tax Break for Multinationals Would Be Poor Stimulus," Center on Budget and Policy Priorities (Jan. 23, 2009), Doc 2009-1539, 2009 TNT 14-71.

20 Matthew Jerome Mauntel, "Stimulating the Stimulus: US Controlled Subsidies and I.R.C. 965," 33 B.C. Int'l & Comp. L. Rev. 107 (2010).

21 Id.

22 Justin Lahart, "Companies Cling to Cash," The Wall Street Journal, Dec. 10, 2010.

23 Thomas J. Brennan, "What Happens After a Holiday?: Long-Term Effects of the Repatriation Provision of the AJCA," 5 Nw. J. L. & Soc. Pol'y 1 (2010).


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