By William A. Raabe (Co-Editor, South-Western Federal Taxation Series).
The Tax Cuts and Jobs Act (TCJA), which was passed late in 2017, made several changes to the U.S. taxation of the taxable income of multinational domestic companies. One of the new rules had the general purpose of encouraging the repatriation of overseas profits to the U.S. by domestic businesses (outside bank accounts, where Congress had discovered an accumulation of approximately $3 trillion that, in their opinion, “belonged” to the U.S. Repatriated funds were subject to a one-time tax at a discounted rate of 15.5%. The tax could be spread over eight years, reducing the tax’s present value.
Another goal of the TCJA was to encourage taxpayers not to move jobs or facilities to other countries that are generating income overseas, particularly income from intellectual property, referred to FDII. This was in response to the perception that US entities were shifting operations overseas because of lower income tax rates. Congress hoped that the Federal corporate income tax rate was cut to 21 percent and the lower tax rate of 13.125% on income earned after the TCJA would encourage domestic business and stop the flow of assets and jobs from the U.S.
Pre-TCJA, offshore profits were a good planning tool. US taxable income only included certain overseas profits when they were transferred (repatriated back to the US). This was why many multinationals opted to defer repatriation at the highest US tax rates, which could reach 35% in some cases.
These funds were not idle in the overseas locations. They were likely used to finance offshore operations, create jobs, and acquire related assets (but not outside the U.S.). Some of these funds were also held in the U.S. at the U.S. branches of the banks from the offshore countries (e.g. the New York branch, Deutsche Bank).
Politicians portrayed the situation as a problem that the Treasury needed to solve (i.e. to get the funds “back home”)
The reduction in the tax rate was only once and appears to have been a success. In 2018, more than $775 billion worth of offshore profits was repatriated to America. Another $100 billion was also repatriated during the first quarter 2019. It is not clear if these repatriations were current profits or payments based on the amount of money that was held over the years. Pre-TCJA, repatriations averaged around $100 billion per annum.
These figures exceeded all government projections. However, President Trump had stated that the provision would bring back $4 trillion to the U.S. post TCJA. This amount was higher than even the Congressional estimates of total unrepatriated money. It may also have included post-TCJA profits which were repatriated immediately.
Stock buybacks, which are a popular method of repatriation under a repatriation tax cut around two decades ago, and increased capital spending may also be evidence of this type of repatriation. Both of these items have seen impressive 2018 increases. Repatriated funds were a key Congressional result. The U.S. saw job creation, and the unemployment rate was low in 2019. However, there may have been other factors.
The FDII provisions have had positive effects on financial statements for 2018 as well as 2019. This is because overseas income was derived from domestic intangible assets. Both Intel and Boeing reported Federal tax rate reductions of approximately 4 percentage points following the TCJA. However, both companies assert that future tax years will see lower tax rates. The TCJA provisions that affect the FDII rules need to be combined with other provisions, including the lower overall federal income taxes rate.
The FDII calculations are based on the amount offshore sales that can be traced back to the taxpayer’s tangibles. However, the tax base is also increased (and the lower rate apples), when the taxpayer shows decreases of investments in US factories or equipment that are used for such income. Although regulations to clarify the computations have not yet been issued, this appears to be a flaw with the construction of the provision. Should the law not encourage capital investment growth in the US?
Defense contractors can use the FDII rate for support and sales of software and other systems. Ask your students to tell you if they believe that these entities should be eligible for a significant tax relief, and if the taxation of profits from government-initiated transactions such as defense goods and services should be subjected to tax.
Should countries compete for business in a global economy?