By: William A. Raabe, Co-Editor of the South-Western Federal Taxation series
Late in 2017, the Tax Cuts and Jobs Act (TCJA) enacted several changes to the U.S.’s taxation of the taxable income of multinational domestic corporations. The general intent of one of the new rules was to encourage the repatriation to the U.S. of overseas profits by domestic businesses (out of offshore bank accounts, where Congress had found accumulations of about $3 trillion that – in their opinion – “belonged” in the U.S.). A one-time tax, at the discounted rate of 15.5%, was assessed on any repatriated funds, the payment of which could be spread out over eight years, thereby reducing the present value of the tax.
Another TCJA goal was to encourage taxpayers to keep jobs and facilities in (or move them back to) the U.S. that were generating overseas income, especially with respect to income from intellectual property and other intangible assets, called FDII. This was a response to the impression that US entities were moving operations overseas, attracted by lower income tax rates there. Congress hoped that the combination of the Federal corporate income tax rate cut (to 21%) and the lower tax rate of about 13.125% on such post-TCJA income allowed under the new provisions would spur domestic business and stop the outflow of jobs and assets from the U.S..
Keeping overseas profits in offshore countries had been an effective pre-TCJA planning technique. US taxable income included certain overseas profits only when those profits were transferred (repatriated) back to the US, so the clear incentive for many domestic multinationals was to defer repatriation from the world-highest US tax rates, which could reach 35% for some entities, for as long as feasible.
Certainly, these funds were not “idle” in the overseas locations; they likely were used to finance offshore operations, creating jobs and acquiring related assets (but outside the U.S.). Moreover, some of these funds actually were held in the U.S., in the U.S. locations of the banks of the offshore countries (say the New York branch of the Deutsche Bank).
In any event, politicians painted the situation as a problem for the Treasury to solve (i.e., to get those funds “back home”).
The one-time reduced-rate tax appears to have been successful. More than $775 billion in offshore profits were repatriated to the U.S. in 2018, and another $100 billion was repatriated in the first quarter of 2019. One cannot yet determine whether these repatriations constituted current profits or payments from the amounts stockpiled over past years. Repatriations pre-TCJA averaged about $100 billion per year.
These amounts topped most government projections, although President Trump had said that the provision would bring $4 trillion back to the U.S. post-TCJA; that amount exceeded even the Congressional estimates of the total unrepatriated cash, so it may have included post-TCJA profits that were repatriated immediately.
Repatriation by means other than cash payments may be evidenced by stock buybacks (a device popular under a repatriation tax cut about two decades earlier), and by increased capital spending. Both of these items seem to have shown impressive 2018 increases. Job creation in the U.S. with repatriated funds was a desired Congressional result from the tax law changes; hiring was strong and unemployment rates were low in 2019, but there may be multiple causes behind these results.
Financial statements for 2018 and 2019 show some positive results from the FDII provisions, such that overseas income was produced from domestic intangible assets. Boeing and Intel both reported Federal tax rate cuts of about 4 percentage points post-TCJA, although both assert that the tax rate reductions will be lower in future tax years. Assessments of the effects of the FDII rules must be combined with other TCJA provisions, though, including the lower overall federal income tax rate.
The FDII computations are based on the amount of offshore sales that can be traced to the taxpayer’s intangibles, but the tax base also is increased (and the lower rate apples) when the taxpayer shows decreases in investments in US factories and equipment that are used to produce such income. Regulations to clarify the computations still haven’t been issued, but this seems to be a flaw in the construction of the provision. Shouldn’t the law encourage the growth of capital investment in the US?
The FDII rate is available to defense contractors, say for the sales and support of software and other systems. Ask your students if they think that sales by these entities should qualify for a significant tax break, and whether the taxation of profits from the sales of government-initiated transactions like defense goods and services should be subject to tax at all.
- In a global economy, should countries compete for business with “dueling tax rates”? Discuss.
- Intellectual property is highly “portable,” making the taxation of resulting profits extremely difficult for a single government to tax. Devise a means by which the taxation of income from intangibles could be computed and apportioned by a group of countries, acting in concert. You might analogize this approach to a tax treaty among the countries of the G7, NATO, or OAS. Be creative, but limit your discussion to the profits from one type of intellectual property, such as software or media products.
- The FDII provisions offer a reduced tax rate on specified income only to domestic taxpayers. That sounds like an impermissible export subsidy under World Trade Organization rules. Have challenges to the provision been raised by the WTO or by other countries? Discuss the validity and status of the possibility of this challenge in an email to your economics instructor.
- Trace the history of the no-tax-until-repatriation rules. What problems were the provisions designed to solve? Who supported the rules? What prior law did the provisions replace?
- Update the statistics in this blog post with newer data from the Commerce Department. Compare the updated data set to the projections used by Congress to support the TCJA changes.
Interested in earning FREE CPE Credit? Reach out to your Cengage Account Executive to be added to the mailing list for upcoming events!