The American Jobs Creation Act of 2004 (the Act), enacted on
October 22, 2004, provided a limited window in which U.S. corporations
could elect, for one taxable year, to exclude 85% of certain
dividends from foreign subsidiaries from U.S. taxable income.
Typically a U.S. shareholder pays tax on 100% of dividends received
from controlled foreign corporations (CFCs), although a foreign
tax credit may be allowed based on taxes paid by that CFC in
foreign countries. This 85% exclusion reduces the effective U.S.
tax rate on these dividends from 35% to 5.25%.
This preferential treatment for foreign dividends was intended
as a short-term economic stimulus, and as such, the benefits
are tied to the reinvestment of those dividends in the United
States. In order to qualify for the deduction, dividends must
be described in a domestic reinvestment plan approved by the
taxpayer’s senior management and board of directors. This plan
must provide for the reinvestment of the repatriated dividends
in the United States, including as a source for the funding of
worker hiring and training, infrastructure, research and development,
capital investments, and the financial stabilization of the corporation
for the purposes of job retention or creation.
Foreign dividends are only excludable to the extent that they
exceed the average dividends repatriated in the last few years.
If a company has a history of bringing foreign earnings back
into the U.S., then they would have to exceed that normal repatriation
level in order to receive any benefit from the new law. In addition,
the amount of dividends otherwise eligible is reduced by any
increase in the related-party indebtedness of the CFC, thereby
preventing a dividend exclusion from being claimed in cases where
the U.S. corporation has funded the dividend being paid by the
CFC.
It should be noted that no foreign tax credit is available for
foreign taxes attributable to the deductible portion of these
dividends. This one-time exclusion is available for dividends
received either during the taxpayer's last tax year beginning
before October 22, 2004, or during the taxpayer's first tax year
that begins during the one-year period beginning on October 22,
2004 (e.g. the 2004 or 2005 calendar years).
Time is running short, but companies still have a chance to
take advantage of this powerful opportunity. The details and
limitations of this deduction are complicated and should be addressed
in great detail before deciding on a repatriation strategy.
For
more information or tax assistance, please contact Aaron Thompson
with Mountjoy & Bressler LLP at (502) 992-2741 or
athompson@mountjoybressler.com.
