Tax repatriation refers to the tax imposed by the U.S. on the return of money that multinational corporations make overseas. Under the corporate tax law, corporations pay taxes on all profits made domestically but do not pay taxes on corporate earnings from abroad until that money is returned.
Read on to learn how companies defer paying taxes to the Internal Revenue Service for as long as possible, using a range of accounting techniques to keep money in favorable tax havens.
How Repatriation Tax Works
Tax repatriation applies when a multinational corporation brings back profits from overseas to the U.S. The company is required to include the returned profits as taxable income on its U.S. tax return, after a credit for foreign taxes paid. Tax repatriation does not apply to individual tax returns, so it does not offer an individual an opportunity for tax relief.
For example, say a company has a subsidiary in a country that charges a 10 percent corporate tax rate. If the subsidiary makes $1 million in that country, it would pay $100,000 in taxes to that country, leaving the company with $900,000 to invest in its business.
If the company then sends that $900,000 back to the American parent company, the company must include the entire $1 million of pretax income on its U.S. tax return. If the company pays a tax rate of 35 percent in the U.S., it would owe $350,000 in taxes that would be partly offset by the $100,000 in tax credits for foreign taxes paid, leaving a total bill of $250,000.
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Why Multinational Corporations Keep Profits Abroad
Companies leave money abroad as a tax strategy to defer paying U.S. taxes on the profits. Those taxes are deferred, but the company can reinvest the profits so they can grow at a faster rate. Continuing the example, many companies would prefer having $900,000 to invest in a foreign country rather than $650,000 to invest in the United States. Only as cash influxes are needed in the American operations will the company likely choose to bring money back and pay tax on the repatriated money. An estimated $2.6 trillion in profits was parked offshore, according to the Aug. 31, 2016, report by the Joint Committee on Taxation.
How Companies Shift Income to Foreign Subsidiaries
Companies often shift profits to favorable tax jurisdictions by selling intangible assets, such as patents, to their foreign subsidiaries incorporated in those tax havens. For example, a pharmaceutical company might have a foreign subsidiary own its patents. That way, when drugs relying on those patents are sold, a large portion of the profits can be recorded in the foreign jurisdiction because the patent is owned by the foreign subsidiary.
Tax Repatriation in the Future
Various proposals have been made to offer tax incentives to bring the money abroad back to the U.S. by modifying how foreign earnings are taxed when they are repatriated. Some proposals call for a repatriation tax holiday in which foreign earnings could be repatriated at a reduced tax rate to encourage businesses to reinvest the money into the U.S.
Another proposal calls for a border adjustment tax, which would impose an additional tax on all imports to the U.S. to encourage domestic manufacturing. It remains to be seen if any of these proposals will make it through legislation.