US Multinational Corporations
US multinational corporations with earnings parked in offshore holding companies have been given leave to bring the earnings back temporarily to the United States without triggering US income taxes.
The move is part of the US government effort to ease the credit crisis. However, the IRS is cracking down at the same time on other ways of repatriating earnings that companies insist do not trigger taxes.
The United States taxes US corporations and American citizens on worldwide income. It does not matter where the income is earned or whether it is brought back to the United States. However, US companies with active business operations in other countries can usually defer US taxes on the earnings by operating overseas through offshore holding companies. As long as the earnings remain outside the United States, tax is deferred until the earnings are repatriated. It is only possible to defer US taxes on income from an active business, like a factory in China or Brazil. Dividends, interest and other forms of passive income are taxed in the US without waiting for repatriation.
US companies must be careful not to make effective use of earnings in the United States before they are formally repatriated. An example of effective use is where a US parent corporation has its Bermuda holding company guarantee repayment of a bank loan to the parent in the United States.
IRS policy since 1988 has been to allow temporary loans of up to 30 days at a time by offshore subsidiaries to their US parents without triggering US taxes. However, a subsidiary cannot have loans outstanding for 60 or more days during a single tax year.
In early October, the IRS said it will allow loans of up to 60 days and no more than 180 days in total. The relief is temporary. It applies only during the 2008 and 2009 tax years. The relevant tax year is the tax year of the foreign subsidiary making the loan. The IRS announcement is in Notice 2008-91.
Companies that renew loans too quickly after the initial term has run risk having the IRS treat the borrowings as a single loan. Some tax experts argue that a 13-day or shorter break between two 60-day loans will cause aggregation, while a wait of at least 52 days is safe. Whether the IRS will aggregate if the wait is 14 to 51 days is unclear.
A trade group representing corporate tax directors called on the Treasury in mid-October to extend the time periods because of the deteriorating financial situation. The group said 60 days is too short even to fund corporate operations through the end of 2008 and called on the government to allow loans of up to six months to a year. It is not clear the Treasury has authority on its own to extend the period that long without a vote by Congress.
Meanwhile, the IRS issued regulations in late June to crack down on an approach it said some US companies have been using to claim tax-free repatriation. In one example of the tactic, a US parent company has two US subsidiaries, A and B. A has a foreign subsidiary. Its foreign subsidiary makes a capital contribution of 10% its own shares and 90% cash to B in exchange for shares in B. Making a capital contribution to a corporation does not usually trigger taxes. The IRS put a halt to such in-bound capital contribution transactions as of June 24.
However, it took a more generous view of a transaction in a private ruling made public in August. Two affiliated companies — one US and one non-US — formed an offshore partnership with a third party. The three partners, 1, 2 and 3, each contributed cash to the partnership. The partnership then bought a US business from the US partner 1 and a foreign business from non-US partner 2. The non-US partner took back “tracking interests” that tracked the economic results just of the business it sold. The IRS said that none of its earnings would be considered “invested in United States property,” meaning effectively repatriated.
The business positions of the two affiliated partners, 1 and 2, were improved because the partnership allowed the businesses to attract new capital. The ruling is Private Letter Ruling 200832024.