Many US companies have found success operating overseas. Success, however, brings with it the question of what to do with cash accumulated in foreign countries. Determining whether to invest cash overseas or repatriate it to the United States is central to an effective cash management strategy.
Cash repatriation planning must balance financial, operational, and tax considerations. An effective strategy will benefit a company’s worldwide tax burden while furthering the company’s goals and getting cash to where it’s needed.
Before choosing to repatriate cash to the United States, companies should first weigh their options to find tax-efficient ways to do so. Below is an overview of repatriation tax-planning strategies and key benefits for multinational companies that covers the following questions:
What Is Cash Repatriation?
Cash repatriation is the process of bringing accumulated cash from a foreign jurisdiction back to the headquarter country of operations. Cash repatriation can take many forms, from dividends paid by a foreign subsidiary to its US parent company, to related party loans, royalties, and management fees.
What Are the Effects of Cash Repatriation?
Cash repatriation allows successful multinationals to return cash to the US. However, it may result in taxable income or withholding tax.
For example, if a US company’s China subsidiary distributes earnings to its US parent, the distribution may be subject to withholding tax in China, and taxed as dividend income in the US.
Before deciding upon a means of repatriation, companies should determine the tax cost of each method, and any alternatives to mitigate that cost.
How Did Tax Reform Affect Cash Repatriation?
Prior to the tax reform reconciliation act of 2017, often referred to as the Tax Cuts and Jobs Act (TCJA), US companies could generally defer US taxation of their foreign corporations’ earnings by not paying dividends and instead letting earnings accumulate in a foreign subsidiary. Some US international tax rules still resulted in taxation of foreign corporations’ earnings—such as Subpart F income—but were limited in scope. Many US companies used this rule by deferring cash repatriation.
The TCJA imposed a one-time repatriation tax on profits accumulated in foreign corporations, impacting many multinational companies. It also created what’s called the global intangible low-taxed income (GILTI) regime. Due to GILTI, companies must now generally pay tax on their foreign earnings in the year the income is earned, regardless of whether there were actual distributions, meaning the income is considered previously taxed income.
How Are Funds Repatriated?
Multinational companies may choose from a number of ways to repatriate cash to the United States. These include:
- Dividend repatriation
- Interest from related party loans
- Management fees
Companies must weigh the practicality of each method with the need to achieve a competitive tax rate.
Dividends, or payments to shareholders out of company profits, is a mechanism often used to repatriate cash. Dividends received from foreign corporations generally result in taxable income in the United States. However, corporate US taxpayers may be able to claim an exemption for dividends received from foreign corporations.
If a foreign corporation’s earnings have already been taxed in the United States due to one of numerous US international tax provisions, a dividend may be treated as a tax-free distribution rather than as a taxable dividend. Tax-free dividends are further discussed below.
Interest from Related Party Loans
Multinational firms may loan money from the United States to a foreign subsidiary. Foreign earnings are then repatriated through repayment of the loan principal and interest, with interest expense in the foreign country and interest income in the United States.
This approach should be a consideration for companies who have income tax rates in foreign countries that are more than the income tax rate in the United States. Companies should also consider any debt-to-equity rules that may apply in the local country, which may limit interest expense deductibility.
If intellectual property is held in the United States, companies may choose to license the use of intellectual property to a foreign subsidiary. This results in royalty income being recognized in the United States and expense occurring in the foreign country. As with interest, repatriation via royalty income depends on if the income tax rates in the United States are lower than those of the foreign country.
US corporations may be eligible for tax benefits on foreign-source royalty income. Given the current economic climate, there may be opportunities to increase or decrease royalty amounts depending on the type of intellectual property.
A US company that provides services for its foreign subsidiaries should charge a management fee, resulting in income in the United States and expense in the foreign country. These are often calculated using a cost-plus mark-up on the expenses incurred.
Services that may qualify for a management fee include executive services and shared services, such as legal, human resources, and accounting. Executing a management fee between two companies is another way to repatriate cash from the foreign country back to the United States.
Can a Dividend Be Treated as Tax-Free Distribution?
In some cases, a dividend can be treated as a tax-free distribution rather than a taxable dividend. There are a few factors that determine whether dividends are tax free:
- Has the income been taxed?
- Is the dividend exempt from tax?
- Does Section 962 apply?
Has the Income Been Taxed?
In general, if a foreign corporation’s earnings have already been taxed in the United States, the earnings aren’t taxed a second time. Earnings that have been taxed are called previously taxed income. As mentioned above, due to GILTI, companies need to pay tax on their foreign earnings in the year the income is earned.
Is the Dividend Exempt from Tax?
In general, a dividend that is a distribution of previously taxed income is a tax-free distribution for US tax purposes. Due to the repatriation tax in 2017, and GILTI in following years, many foreign subsidiaries of US companies have significant amounts of previously taxed income that may allow for tax-free distributions.
Additionally, as part of the TCJA, US Congress created an exemption from tax that may apply to dividends paid from foreign corporations to US corporations. Learn more about Section 245A here.
Does Section 962 Apply?
There are significant differences between how the United States taxes individuals and corporations that own foreign corporations. Individuals may make an election under Internal Revenue Code (IRC) Section 962, which allows the individual to be treated as a corporation with respect to certain income from foreign corporations.
While there are tax benefits to this election, there are significant impacts on a taxpayer’s previously taxed income and the tax effects of future cash repatriations. Individual taxpayers should consider the tax impact on future cash repatriation before making a Section 962 election.
How Does Your Organization Need to Account for Foreign Taxes?
A cash repatriation strategy needs to account for income and withholding taxes in foreign countries. Otherwise, it may reduce US tax but increase a company’s worldwide tax bill.
Many countries impose withholding taxes on dividends, interest, royalties, and other payments to foreign persons. The withholding tax rate imposed depends on whether there’s an income tax treaty between the United States and the foreign country. If a treaty exists, and if the beneficial owner of the dividend is eligible for treaty benefits, withholding taxes can often be reduced below the payer country’s statutory rate.
Although US companies may be able to claim a foreign tax credit for withholding taxes paid, withholding taxes should be considered prior to repatriating cash.
Foreign Taxable Income
A cash repatriation strategy should consider how the payment will be treated in the foreign country. A payment that results in income in the United States but doesn’t create an expense in the foreign country may not optimize a company’s worldwide taxes due. For example, many countries impose a limitation on interest expense, meaning an interest payment may result in interest income in the United States but no expense in the foreign country.
We’re Here to Help
When repatriating cash from abroad to the United States, multinational companies should consider the expense of doing so, the resulting US income taxes, and the potential foreign-tax impact.
To learn more about cash repatriation and whether or not it’s the right approach for your multinational company, contact your Moss Adams professional.