§ 965 Repatriation?

Keep One Eye on the Apple, the Other on the Four-Year Statute

In 2004 and 2005, many U.S. corporations received significant dividends from foreign subsidiaries because of the special federal tax benefit available in those years under I.R.C. § 965. Billions of dollars of dividends were repatriated.

For California water’s-edge filers, the questions are:

  •  Can those dividends be eliminated altogether? 
  • If not, does the dividend-received deduction apply? 
  • In any event, can the interest deduction disallowance provisions be avoided? 
  • If the dividend is included, or if a portion of the interest deduction is disallowed, may the factors of the foreign subsidiary be included?

Tens of millions of California tax dollars hinge on the answers to these questions. Most typically, a taxpayer did not eliminate the § 965 dividend, but instead only partially deducted the dividend. Also typically, a taxpayer significantly reduced its interest deduction attributable to its investments in foreign subsidiaries. By contrast, few water’s-edge taxpayers increased the denominators of their apportionment factors related to the property, payroll and sales of foreign subsidiaries.

Now taxpayers are considering refund claims. Most commonly, a refund claim would be based on eliminating the dividend altogether, deducting all interest without offset for foreign investments, or including factors from dividend-paying subsidiaries.

With respect to the first two issues, taxpayers who are thinking about filing these claims are closely following recent developments:

  • In January, Apple, Inc. filed its complaint in Superior Court in San Francisco. Apple is challenging the Franchise Tax Board’s refusal to allow it to eliminate dividends it received from foreign subsidiaries. In doing so, the Board is refusing to follow the Fujitsu decision out of the First District Court of Appeals. Not only is the Board refusing to follow Fujitsu, but it is also disallowing a portion of Apple’s interest deduction, apparently in conflict with the decisions of the Superior Court in American General and the State Board of Equalization in Appeal of Zenith. We expect this litigation to warm up this summer. 
  • In an unusual move, the Franchise Tax Board Thursday, March 6, deferred consideration of its proposed regulatory amendments related to the ordering of dividends. (Amendments to CCR 18 §§ 24411 and 25106.5-1.) This regulation proposes to avoid the Fujitsu result (which for many taxpayers is full elimination of foreign dividends), by administrative fiat. Many thought that the Board, at the hearing, would approve the proposal, putting it on the path to adoption. The Board’s decision to defer consideration was interpreted by many to be an acknowledgement that the proposal is inconsistent with the Board’s legislative proposal on dividend ordering.

Meanwhile, taxpayers have marked their calendars for the four-year time limit on refund claims so that they can protect their rights to a refund related to the tax year in which they received the § 965 dividend