Most of the profits from the foreign operations of U.S. corporations are not taxed by the United States until they are sent home to the parent companies. So to avoid U.S. tax, many domestic companies bottle up large pools of cash in their foreign subsidiaries. The bottles were uncorked temporarily by the enactment of the American Jobs Creation Act of 2004. If some conditions are met, the new section 965 allows — for one year only — corporations to pay tax on repatriated foreign earnings at the rate of only 5.25 percent, instead of the usual (maximum) rate of 35 percent.
For many companies, it was a golden opportunity. Previously we reported that the top nine U.S. pharmaceutical companies repatriated $98 billion at the reduced rate. This article extends the inquiry to 40 high-tech companies. According to their most recent annual reports, those firms repatriated a total of $57.7 billion under the favorable terms provided by the Jobs Act. (See the table below.)
Unlike the 9 pharmaceutical companies, which all took advantage of the 5.25 percent rate, only 21 of the 40 high-tech companies we studied did. (When their last annual reports were issued, two companies were unsure of whether they would take advantage of the provision.) Among the 21 high-tech firms, the average repatriation amount was slightly below $3 billion — considerably less than the $10 billion average for pharmaceutical companies.
At the top of our new list is Texas-based Hewlett-Packard Co., which brought home $14.5 billion.
When dividends from foreign subsidiaries are essentially locked out because of the tax waiting for them at the U.S. border, the domestic economy can pay a price. After all, foreign earnings are a potential source of funds for U.S. capital formation. More capital means more productivity, and more productivity means wages can increase without inflation.
Everyone has a solution to the problem. If the United States moved to a territorial tax system — the dream of conservatives — the lockout effect would disappear: No U.S. tax would apply to foreign earnings, whether or not they were repatriated.
If the United States repealed all tax deferral (which the subpart F rules allow for active foreign income) and moved to a true worldwide system — the dream of liberals — the lockout effect would disappear: A 35 percent tax would apply to all foreign earnings, whether or not they were repatriated.
And even if the United States split the difference and taxed foreign earnings on an accrual basis at half the full rate, the lockout effect would disappear: A 17.5 percent tax would apply to all foreign earnings, whether or not they were repatriated. A split-rate system would be an evenhanded compromise.
The current system is an awkward compromise between the two extremes. It provides more relief for some companies than others. Those who can defer repatriation get a larger tax benefit than those who can't. And everyone must squirm to get the benefit; taxes become a disproportionately large factor in the decision to repatriate funds.
With its one-shot repatriation relief, Congress jury-rigged a klutzy appendage onto an already overbuilt international tax regime. It's hard not to be cynical about what Congress has wrought. First, the provision is needlessly complex and poorly drafted. To get it to work requires mountains of paper shuffling by some of the best minds in hundreds of corporate financial and legal departments. Much of the complexity stems from the bogus requirement that repatriated funds must be used for documented job-creating activities.
Second, to minimize the short-term revenue loss and to prevent the repatriation relief from backfiring by changing into a provision that discourages domestic investment, Congress promised that it would never again provide that relief. That is a promise it cannot keep. As time passes and memories fade, as congressional leadership turns over, as earnings pile up in bank accounts of foreign subsidiaries, and as the economy inevitably falls into serious distress, Congress will no doubt be tempted to repeat its one-shot relief.
For this article, a high-tech company is any firm in the Fortune 500 classified under any of the following six industry categories: computer software; computers, office equipment; information technology services; medical products and equipment; network and other communications equipment; and scientific, photo, control equipment.
Of the remaining 19 companies surveyed but not included in the table on p. 556, 2 companies had not yet made a decision on repatriation but had indicated maximum amounts for their potential repatriations. Apple Computer indicated in its latest annual report (filed Dec. 1, 2005) that $755 million may be eligible for repatriation under the provisions. Affiliated Computer Services said in its most recent annual report (filed Sept. 13, 2005) that it was considering a repatriation amount of up to $36.5 million.
Three companies — Electronic Data Systems Corp., Sanmina-SCI Co., and Corning Inc. — explicitly reported they would not be repatriating any funds under the special temporary provisions.
Fourteen companies gave no indication of their intentions to repatriate funds, and from that it may be assumed that none of them made significant repatriations. Falling into this last category are Xerox Corp., Sun Microsystems Inc., NCR Corp., Pitney Bowes Inc., Computer Sciences Corp., Science Applications International Corp., Unisys Corp., Lucent Technologies, Avaya, Danaher Corp., Solectron Corp., Jabil Circuit Inc., Advanced Micro Devices, and Micron Technology Inc.