John Kaufmann
Published: 2005
Total Pages: 0
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Were it not for new section 965, says Kaufmann, this would not be a good year to repatriate high-taxed income from foreign subsidiaries. That is because the U.S. dollar is under pressure, and the rules for translating a foreign subsidiary's foreign income tax pool and earnings and profits increase the value of indirect foreign tax credits in years in which the dollar is stronger against the subsidiary's functional currency, and decrease the value thereof in years in which the dollar is weak against the subsidiary's functional currency. Under section 902(a), a domestic corporation that owns 10 percent or more of the voting stock of a foreign corporation from which it receives dividends in a tax year is deemed to have paid an amount of foreign taxes equal to the product of the foreign corporation's post-1986 foreign income tax pool and a fraction, the numerator of which is the amount of the dividends, and the denominator of which is the foreign corporation's post-1986 undistributed earnings. Under section 986(a), foreign income taxes of accrual-method taxpayers are generally translated at the average historical exchange rate for the year in which they relate. However, under sections 986(b) and 989(b), earnings and profits of foreign corporations are translated at the spot rate on the date of distribution. As the author demonstrates in arithmetical examples, that means that the denominator of the section 902 fraction will increase relative to the numerator in years in which the subsidiary's functional currency is strong relative to the dollar, and the denominator of the section 902 fraction will decrease relative to the numerator in years in which the U.S. dollar gains against the subsidiary's functional currency. Kaufmann explains that under new section 965, domestic corporations that receive cash dividends from controlled foreign corporations that are invested in United States infrastructure may deduct 85 percent of the excess amount thereof. The excess amount is equal to the excess of cash dividends from the CFC's received during the tax year over the base period amount. The base period amount is the amount equal to average dividends received by the taxpayer from CFCs during a base period. Taxpayers may benefit from section 965 for only one tax year, which may be either the last tax year that begins before the date of enactment of section 965 or the first tax year that begins during the one-year period beginning on the date of enactment. Taxpayers that do not elect to use the benefit of section 965 during that time period lose it. Taxpayers that make an election under section 965 may benefit from two allocation rules according to Kaufmann. First, they may specifically allocate dividends between the excess amount and the base period amount. Second, they may allocate dividends in excess of the base period amount between the deductible and the nondeductible portions of the excess amount. Because both the base period and the nondeductible portion of the excess amount are included in taxable income, it is beneficial to the taxpayer to allocate high-taxes income to these amounts, and to allocate low-taxed income to the deductible portion of the excess amount. Given significant volatility in the price of the dollar, Kaufmann explains that taxpayers will also benefit from allocating dividends from CFCs in high-tax jurisdictions paid on dates when the spot rate favors the dollar to the base period amount and the nondeductible portion of the excess amount, and dividends paid on dates when the spot rate favors the CFC's functional currency to the deductible portion of the excess amount. Because those allocations are made on the taxpayer's return, which is filed after the taxpayer's tax year has closed, they differ from most other trading decisions because they may be made with the benefit of hindsight.
