Out of Exile

The tax cut on foreign earnings only seems restrictive. But some companies remain wary.

Fortunately, the law doesn’t require companies to sell their factories. Instead, it allows foreign subsidiaries to borrow money for repatriation. But that can raise credit issues. In May, Moody’s issued a paper warning companies that it will be watching how they repatriate their money and what happens to it once it’s in the United States. In particular, Moody’s warns of “structural subordination” — cases in which a subsidiary borrows money and the terms of the loan give the lender a claim on the unit’s cash flows that is superior to that of the parent company. This could keep the parent company from tapping the subsidiary’s cash to meet other obligations.

Finally, there are foreign tax credits (FTCs) to worry about. Ordinarily, the U.S. tax code allows companies to take a full credit for any foreign taxes they have paid. But under the American Jobs Creation Act, FTCs shrink along with the tax rate. Consider the example of a company with $100,000 in foreign earnings. If the company had already paid $20,000 in foreign taxes on those earnings, it would ordinarily be entitled to reduce its $35,000 U.S. tax bill by that full amount. But under the new law, the U.S. tax bill falls 85 percent, to only $5,250, and the tax credit falls by the same percentage to just $3,000, leaving the company with a final bill of $2,250.

Since the tax credits are worth much less this year, says Mark Weinstein of Hogan & Hartson LLP in New York, the company would do better to bring earnings home from a low-tax country like Ireland or Switzerland (where the FTCs would be small) than from a high-tax jurisdiction like France. That way, a company can save its more-valuable FTCs for the day when the U.S. tax rate returns to 35 percent. That’s currently slated to happen for fiscal years beginning on or after October 22, 2005. “It requires careful planning, but if you can find low-taxed foreign earnings to repatriate — and can identify the source of the repatriation — you’ve done yourself a favor,” says Weinstein.

Still, companies have only until the end of this fiscal year to make their plans. Not many anticipated the law, and when it passed many delayed their work until the Treasury Department clarified the rules. “It surprised many companies — most didn’t think it would ever be passed,” says Senyek. “But even so, it has turned out to be a nice gift to corporations.”

Don Durfee is research editor of CFO.

Bringing the Money Home
A sampling of what companies say they will repatriate, and how they intend to use the cash.
Company Amount to Repatriate Announced Use
Pfizer $39 billion R&D, advertising and marketing, nonexecutive compensation, balance-sheet improvement
Eli Lilly $8 billion Operating expenses and $2 billion this year for capital expenditures
Dell $4.1 billion $100 million manufacturing facility in North Carolina
Kellogg $1 billion “Close-in” acquisitions
Sources: Company announcements, press reports

Forbidden or Not?

If Washington had really wanted to encourage companies to use repatriated earnings to create jobs, lawmakers could have required them to set up separate legal entities so expenditures could be tracked. Instead, Congress settled on a list of prohibitions that may have little real influence over how companies ultimately spend their money.

Quasi-Prohibited Investments

  • Executive compensation
  • Intercompany transactions
  • Dividends and other shareholder distributions
  • Stock redemptions
  • Portfolio investments
  • Debt instruments
  • Tax payments

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