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Calls have been heard for a replication of the "tax holiday" bestowed by the 2004 American Job Creation Act, specifically the one-year-only provision granting an 85 percent dividends-received deduction to U.S. corporations for repatriations of foreign subsidiaries' earnings. The goal was to attract cash held abroad, to be invested in domestic facilities and for the hiring of American workers. Of the estimated $1 trillion of earnings then held abroad, perhaps $350 billion were repatriated. Today, with as much as $1.5 trillion held by foreign subsidiaries, as much as $500 billion of fresh capital inflows could presumably be generated.

Academic and other research suggests that the funds repatriated by the 2004 AJCA failed to achieve the stated objective, and that stock buy-backs and dividends paid by the parent companies absorbed more than 90 percent of the remittances - although funds returned to shareholders in this way, when later deployed for consumer purchases or personal or business investments, might have had a similarly salutary impact.

U.S. companies' disinclination to repatriate the earnings of foreign subsidiaries arguably was not primarily motivated by the availability of a tax deferral, but rather by the perceived lack of profitable domestic investment opportunities. One study found that domestic operations of U.S. multinationals were not financially constrained at the time of the AJCA, meaning that the paucity of job-boosting domestic outlays was not due to a lack of investable funds, but rather to the dearth of profitable opportunities. The ability to access capital at a lower cost (via tax-favored repatriations) would not be expected to boost domestic investment, domestic employment, or R&D under such circumstances.



Aside from opportunities for investment, a factor weighing on 2004 repatriation decisions was the impact on reported earnings. If a similar tax holiday were to be declared today, this concern will be made more complicated by the fact that, increasingly, companies are able to choose between U.S. GAAP and International Financial Reporting Standards for general-purpose external reporting. CPAs may wish to educate clients about the divergent reporting implications of earnings invested or retained by foreign subsidiaries between these two reporting regimes.

The Internal Revenue Code taxes U.S. companies on worldwide income, but IRC 951-965 provides for deferral (not exemption) of taxes if foreign subsidiaries' earnings are not repatriated. Under both GAAP and IFRS, accrual-basis financial statements are to report the tax effects of income and expense reported in the current period, whether or not taxes are currently remitted to the taxing authorities, but with limited exceptions, one of which pertains to certain unrepatriated earnings of foreign subsidiaries.

Under GAAP, "It should be presumed that all undistributed earnings of a subsidiary will be transferred to the parent company [and that accordingly] the undistributed earnings of a subsidiary included in consolidated income should be accounted for as a temporary difference." However, there is an exception "if sufficient evidence shows that the subsidiary has invested or will invest the undistributed earnings indefinitely or that the earnings will be remitted in a tax-free liquidation."

In other words, tax expense will not be recognized currently if the earnings will not be taxed in the U.S. until repatriated, but only if the taxpayer has "evidence of specific plans for re-investment of undistributed earnings of a subsidiary which demonstrate that remittance of the earnings will be postponed indefinitely." Historical experience and future plans for operations and remittances may justify such non-recognition, and this explains why many U.S. multinationals report low overall effective tax rates, by invoking this so-called "indefinite reversal criterion." (When conditions change, income tax obligations are to be fully accrued, even if repatriation remains in the distant future).

Thus there is a relatively high hurdle for the non-recognition of the tax effects of the earnings of foreign subsidiaries of domestic corporations, whatever the tax laws might require for current tax obligations. It is incumbent upon the reporting entity to demonstrate, by reference to its historical actions and its current, documented plans, that foreign earnings will be re-invested abroad indefinitely, with no intention to repatriate.

This same basic concept is set forth under IFRS, which provides an exception that supports the non-recognition of the tax effects of the unremitted foreign earnings, under limited circumstances, but the criteria differ between these two financial reporting regimes. It is hypothesized that this difference could influence the behaviors of companies that may have reasons to maintain foreign earnings outside the U.S.

Under IFRS, the reporting entity must recognize a deferred tax liability for all taxable temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint ventures, unless both of these conditions are satisfied:

The parent, investor or venturer is able to control the timing of the reversal of the temporary difference; and,

It is probable that the temporary difference will not reverse in the foreseeable future.

Two terms in the foregoing -"probable" and "foreseeable future" - could be subject to some debate. Under IFRS, the term "probable" is generally understood as being a likelihood greater than 50 percent, i.e., when an event is "more likely than not" to occur. However, that definition is not found in IFRS, and the term "probable," used some 28 times in that standard, is never given a formal or operationalizable definition. Under U.S. GAAP, although also not officially defined, "probable" is taken to imply a likelihood of upwards of 85 percent - clearly a much higher threshold than "more likely than not." Given these implied definitions, the IFRS standard imposes a much lower threshold for non-accrual of tax obligations than the corresponding one under GAAP.

Although also not defined, the IFRS term "foreseeable future" implies a more proximate horizon than is suggested by the corresponding GAAP term, "indefinite." Thus, it would be easier for management to assert that any repatriation of foreign earnings is not expected in the foreseeable future (the IFRS guideline) than it would be to assert a positive intention to indefinitely re-invest those earnings abroad (the U.S. GAAP criterion).

Taken together, the terms "probable" and "foreseeable future" under IFRS suggest that it would be more feasible for corporations reporting in IFRS to justify not providing deferred taxes on unremitted foreign earnings, where (as for U.S. corporations) those taxes will not become payable until there is a repatriation to the parent company.

As the U.S. now permits reporting under IFRS - and the Securities and Exchange Commission may eventually mandate the use of IFRS as the successor to U.S. GAAP - this would suggest that deferred tax obligations for unremitted foreign earnings may increasingly go unreported until, and if, repatriation occurs.

Accountants and auditors should be aware of these differing rules regarding the current recognition of tax effects of foreign earnings that have yet to be remitted to the U.S. It is possible that this could be a deciding factor when clients are contemplating electing to report under either U.S. GAAP or IFRS, and at the minimum needs to be given consideration, among a range of other factors, when seeking to optimize clients' financial reporting.


Barry Jay Epstein, Ph.D, CPA, CFF, is a partner at Russell Novak & Co. in Chicago. He is the author of The Handbook of Accounting and Auditing, published by the Tax & Accounting business of Thomson Reuters. Reach him at or (312) 464-3520.

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