Risk and Section 965 Repatriation

The sheer complexity of the repatriation process can affect business operations, financial performance, and financial reporting, both now and in the future.

The new section 965 of the Internal Revenue Code, enacted as part of the American Jobs Creation Act of 2004, offers companies a one-time opportunity to repatriate profits earned overseas with greatly reduced tax consequences. But the saving — in many instances, the effective tax rate on repatriated funds can be reduced from 35 percent to 5.25 percent — is not without risks.

That was one theme to emerge from a discussion between leading finance executives, tax practitioners, and editorial staff from CFO Research Services, who gathered in July to discuss the repatriation provisions in section 965. Participants observed that section 965 poses risks to business operations, financial performance, and financial reporting, both now and in the future, stemming from the sheer complexity of the repatriation process.

Repatriation under section 965 can be as complex, in many cases, as a merger or acquisition, participants agreed. This complexity arises, in part, from the fact that repatriation requires the involvement of many functional areas of the business — ranging from the finance and tax departments to human resources and corporate communications. The sheer number of transactions required to find the cash — as well as the corporate governance exercise of causing controlled foreign corporations (CFCs) to pay a dividend, also contributes to the complexity of the undertaking. Attendees strongly suggested that companies still considering a repatriation under section 965 should accelerate their actions to execute this time-consuming series of transactions. The CFO of one manufacturing company that has successfully executed a repatriation noted that her company’s treasury and tax departments were already studying the possibility of repatriation when section 965 went into effect in October 2004.

While the complexity of the undertaking created work for finance and operating teams, perhaps more importantly, the breadth and scope of repatriation decisions and transactions introduced new risks to their businesses. Several attendees mentioned the risk that the IRS would take a contrary view of the tax treatment at some point in the future, but they also cited risks to the company’s operating and financial position at home and overseas. And while no particular process or framework emerged as the single “right way” to approach section 965 repatriation, the theme of complexity and the risks it creates echoed throughout the discussion:

Qualifying funds. To qualify for the section 965 dividends-received deduction, the U.S. parent must receive the funds in cash. While the CFC may borrow the funds, the statute constrains certain intragroup borrowing; ideally, a third-party lender might certify by letter that the CFC is able to borrow the cash on its own (without relying, for example, on the credit or collateral of its corporate parent). These and other regulatory and borrowing constraints required repatriating companies to unwind and rebuild complicated structures to find funds appropriate for repatriation. The treasurer of a telecommunications equipment company that recently repatriated approximately $100 million (although not under section 965, due to the company’s particular tax situation) explained that his company solved this problem by revamping its international treasury and capital structures before undertaking its repatriation activities — not only to locate pockets of available overseas cash, but also to assess its needs for cash abroad.


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