Will Trump Give Up the Ghost of Tax Holidays Past?

Lessons learned from the 2004 tax holiday and how U.S. CFOs can prepare for repatriation in the future.

Anticipation that President-Elect Donald Trump will overhaul the corporate tax regime with an eye towards bringing back trillions in overseas profits has U.S. senior-level financial executives pondering whether the post-holiday season will bring a shiny new gift of capital or a lump of tax planning coal.

But if the ghosts of tax repatriation past are any indication, next year will require that thoughtful planning and precise execution in the financial suite.

“There's been a debate about whether the tax holiday of 2004 was economically stimulative or not,” says Scott Greenberg, analyst with the Center for Federal Tax Policy at the Tax Foundation. “I think the lesson that we could learn is that bringing cash back doesn't mean that the cash is going to be invested here.”

In 2004 the U.S. enacted a repatriation tax holiday, the goal of which was to encourage companies to reinvest some of their profits held abroad. Though, not all of the evidence points to companies taking the opportunity to return their foreign source profits to shareholders rather than increasing their overall level of investment in the U.S., according Greenberg, the evidence that the tax holiday increased U.S. investment or jobs “is pretty slim."

With a murky history, how do CFOs prepare for a tax holiday or permanent repatriation?

For starters, a useful approach for talking about proposals allowing companies to bring back money from overseas is to look at repatriation holidays, deemed repatriations, and transitional repatriations.

A repatriation holiday is a one-time lower rate on repatriated income from overseas and is entirely elective. The model for this is the repatriation holiday of 2004 and there may be limitations for the uses of the money once it’s brought back.

On the other side of the spectrum is a deemed repatriation, a proposal more prominent in recent conversations. It’s not elective and all money currently tax-deferred overseas would be deemed as if it were brought back and charged at some tax rate. Typically the rate is significantly less than the statutory rate of 35%. Deemed repatriations end up raising more money because they require all assets to be subject to whatever rate is decided on rather than just whatever assets companies want to bring home.

A third category is a transition tax, where you're doing a deemed repatriation but it's in order to transition international tax system to a different paradigm. Greenberg predicts this approach is the most likely to occur, because of the interest among lawmakers of both parties in fundamentally changing the way that U.S. taxation of foreign source profits happen.

For many years Congressional Republicans have been talking about the idea of a territorial tax system which would tax companies based on where they earn money rather than where they're headquartered. Greenberg explains, “Right now if you're a corporation that's headquartered in the U.S., then our tax system reserves the right to take a bite out of your income wherever you earned in the world. A lot of lawmakers, both Democrats and Republicans, have called for a system where you're only taxed by the U.S. government if you do business in the U.S.”

“If you transition to this territorial system, then there's all of this money that companies currently have overseas that is tax-deferred, that hasn't been subject to tax under the world-wide system, and if you moved immediately to a territorial system, then you'd be able to bring that money back tax-free. You could see that as a good thing, in that none of the money is subject to any residual tax by the U.S. government. You might see that as a problematic thing, in that we have the assumption that eventually we would be collecting tax on all of these foreign source profits and we didn't get the opportunity to. That second approach is what leads lawmakers to talk about a transition tax, which is a deemed repatriation in the context of moving the tax code toward a different system of treating international income overall.”

In order to adequately prepare for a transition tax, CFOs must be aware of the size of their deferred tax liability. One of the most important questions is going to be what the tax rate is on repatriated profits. Greenberg says that, in all likelihood, the tax rate will be much lower than the statutory tax rate, which means that CFOs can probably prepare to see an actual tax liability that's lower than the deferred tax liability on their books.

“One interesting wrinkle is that there are some repatriation proposals, such as the Rep. David Camp (R-Mich.) repatriation proposal, that would treat different types of foreign income differently. Specifically the Camp proposal would treat income that's reinvested in physical capital such as equipment and factories and other things differently than it would treat just cash that's held abroad. It would apply a 3.5% rate to reinvested earnings and 8.75% rate to cash and other forms of assets, so it's probably useful for CFOs to at least start thinking about which of their foreign assets fall into which categories.”

When we look at limitations and “strings attached,” we tend to be talking about repatriation holidays, because a holiday is elective. Policymakers might view there being more opportunity to attach strings to the people who do choose to bring their money home. Because a deemed repatriation and a transition tax isn't elective, politicians might be more reticent about trying to tell people what to do with the money they've brought home. Greenberg says, “I think with the latest most prominent proposals for a transition tax, including the Camp proposal of 2014 and the Ryan-Brady proposal of last year, I don't think either of those mentions any limitations on the use of repatriated income other than, of course, that it's going to be taxed upon repatriation.”