Foreign-Profit Tax Break Is Outlined

The New York Times
January 14, 2005
Foreign-Profit Tax Break Is Outlined
By EDMUND L. ANDREWS

WASHINGTON, Jan. 13 - The Bush administration outlined rules on Thursday for a huge one-time tax break for companies that reinvest their overseas profits back into the United States.

The tax break, which was part of last year's corporate tax bill, would allow companies to pay a fraction of the normal tax rate on hundreds of billions of dollars in foreign profits if they pledge to invest the funds in activities that may create jobs at home.

In a setback for many of the biggest potential beneficiaries, the Treasury Department said companies could not use their windfalls for repurchases of stock or increases in shareholder dividends.

Investors reacted with disappointment to the new rules. Stocks of companies that pushed hard for the tax break - Eli Lilly, Hewlett-Packard, Merck, Oracle and Pfizer - all declined slightly after the rules were announced.

The rules would help companies finance some activities that do little to directly increase employment, and a few - like corporate acquisitions - that might lead to job cuts.

The Treasury Department said that the tax break could be used to finance advertising and marketing, even if a company did not plan to increase its advertising.

The administration said companies could also use their foreign profits to pay for corporate acquisitions, redeem old debt and spend on the general purpose of "financial stabilization."

As adopted by Congress last year, the new law would give companies a one-time opportunity this year to bring a total of as much as $500 billion in foreign profits into the United States and pay a tax rate of 5.25 percent, instead of the standard corporate tax rate of 35 percent.

Globe-spanning companies like Hewlett-Packard and Eli Lilly have for years deferred their United States taxes on foreign earnings.

Under traditional tax law, the companies would be required to pay the full tax rate as soon as they brought the money back into the country.

The one-time tax break would let companies take advantage of the lower rate if they put forward a plan to reinvest their profits in ways that enhance employment in the United States.

The law itself was quite broad, explicitly allowing companies to allocate their money for "financial stabilization," corporate acquisitions and research and development.

The Treasury Department, which opposed the provision during the debate in Congress, gave companies even more latitude.

Under the "guidance" published by the Internal Revenue Service on Thursday, companies do not face a specific deadline for actually reinvesting the money and merely have to do so within "a reasonable time."

Nor do companies have to invest more money on hiring or new equipment, or even advertising, than they did the year before. Companies would be able to apply the tax break to investments that they had already planned before their new "domestic reinvestment plan," and even to investments that they had already budgeted and planned to finance with other sources of money.

"The Treasury Department and the I.R.S. do not intend to provide a template for a domestic reinvestment plan," the administration said in its set of guidelines, which totals 39 pages.

Despite the unenthusiastic response from investors to the new rules, the tax break could provide a huge windfall to many technology and pharmaceutical companies that have earned billions of dollars in low-tax countries like Ireland.

Oracle, the business-software company, has estimated that its tax break on foreign profits could be as much as $650 million.

Oracle is hoping to use much of that money to shore up its balance sheet after buying PeopleSoft last year for $10.4 billion.

Many American multinational corporations have deferred taxes on foreign profits. Hewlett-Packard, which wants to strengthen its balance sheet after buying Compaq, has more than $14 billion in untaxed foreign profits. Merck, the pharmaceutical giant, had $15 billion as of 2003. Johnson & Johnson had $12.3 billion.

Wall Street analysts are divided about whether the tax break will actually achieve its intended purpose of attracting a rush of new investment in the United States.

Anne Swope, a tax and foreign exchange analyst at J. P. Morgan, estimated that American companies had stockpiled more than $500 billion in overseas profits.

"We feel confident that $300 billion of that will be repatriated," Ms. Swope said. "The changes in tax law in 1986 made it extremely difficult for companies to repatriate earnings. This is an opportunity to provide temporary relief."

But Jan Hatzius, a senior economist at Goldman Sachs, predicted that the economic impact would be modest because companies have many ways to use their foreign profits without technically bringing them back into the country.

"If companies want to access their foreign assets, it's easy to do," said Mr. Hatzius. "All they have to do is borrow against them."