Bringing back the estimated $2.6 trillion of deferred corporate earnings at a reduced tax rate is a key aspect of almost all U.S. proposals to overhaul the tax system, reports BNA.
There’s strong consensus among policy makers about this one-time tax on companies’ offshore earnings, which would allow them access to the stashed cash while also giving U.S. tax revenue a one-time boost to pay for other aspects of a new tax plan—or for infrastructure improvements.
However, targeting true offshore cash piles rather than genuine foreign investments may prove to be a complex problem and an administrative headache, as it requires an analysis of what constitutes cash as opposed to other investment.
The repatriation issue has, so far, received less focus in the tax overhaul debate than forward-looking aspects, such as the GOP plan to convert the U.S. corporate tax into a border-adjusted tax on cash flow, a common element in several Republican proposals as well as a tax plan offered by former President Barack Obama in 2015.
Both the plan proposed by then-Rep. Dave Camp (R-Mich.) in 2014 and the 2016 Republican blueprint border adjustment tax proposal include dual rates for cash and non-cash holdings. The plans would tax “cash or cash equivalents” at 8.75 percent and other investments at 3.5 percent.
It is unknown how much of currently deferred offshore earnings are held as cash. Accounting rules require companies to report how much is “permanently reinvested offshore” in order to book a tax savings in financial statements, but that amount refers to future plans and could include current cash investments.
The dual rates would, in theory, target offshore cash stockpiles without hurting real brick-and-mortar investments. But determining the categories—and preventing companies from planning around them—could be a difficult issue.
“We don’t really have a very clear definition of cash and cash equivalent in the tax code,” said Peter Merrill, a principal with PricewaterhouseCoopers LLP’s Washington National Tax Services tax practice. “And very little in the way of regulations that provide guidance on that.”
The legislation would also likely need a rule to prevent taxpayers from quickly deploying cash to take advantage of the lower rate, or other gaming techniques. The Camp draft included a look-back rule that averaged the amount of cash holdings from the years prior to the bill’s passage, as well as a more general anti-abuse rule targeting transactions carried out to achieve the lower rate.
But anti-abuse rules can be unwieldy in practice, and the look-back rule could target unlucky companies that happened to make a major investment during the transition years.
“There are a million fact patterns which might be extremely sympathetic, and are not addressed in the law,” Merrill said.
Other difficult examples might include banks with liquidity requirements, prepaid sales or foreign government rules that prevent companies from paying dividends.
The difficulty has led some to argue that dual rates are not only overly complicated, but unnecessary.
“If they need to monetize their foreign assets, they’ll find a way to do that,” said David Rosenbloom with Caplin & Drysdale, who is also a professor at New York University School of Law. “I think drawing distinctions like that is just going to encourage all types of games.”
Susan Morse, a professor at the University of Texas School of Law, has argued for a “pressure washer” approach to deemed repatriation, meaning one should view the tax broadly as a tool that allows for a transition from the old system to one that avoids this issue in the future. Most plans for tax reform would tackle deferred income by either instituting stronger rules to tax worldwide income of U.S. companies, or would exempt foreign income and shift the U.S. to a territorial system.
“It’s a waste of energy to make a picky statute that tries to get the accounting exactly right,” Morse said. “I don’t think the liquidity issue begins and ends with cash.”
Once Bitten, Twice Shy
Observers from all sides of the discussion look to the 2004 American Jobs Creation Act, which included a voluntary repatriation at a 5.25 percent tax rate. The legislation included requirements that the repatriated funds be used for investment, although many studies have concluded that companies used available cash to work around these rules, funneling the repatriated dollars into already planned projects. The Joint Committee on Taxation ultimately found that the legislation didn’t boost revenue for the Department of Treasury.
Disappointment from the 2004 experiment has left many skeptical about trying to dictate how the repatriated dollars should be used.
“There was a lot of criticism of an approach that tried to limit taxpayers on how they used their funds,” said Joshua Odintz, a partner with Baker McKenzie LLP in Washington. “I think this time, it’s a different reason or rationale. The idea is to transition to a new system.”
To be a true transition, the repatriation would have to be mandatory, and it would have to be connected with new tax rules for worldwide income moving forward. There is strong consensus, currently, for both of those conditions—but the difficult politics of overhauling the tax code could lead to some unpredictable directions.
“I think most sensible people would probably pay that price to get to a different system,” Rosenbloom said. “It’s a totally different ballgame if it’s another bridge to nowhere.”