Friday, November 10, 2006

American Jobs Creation Act: You're Welcome

I was reviewing the 10-K for Zale Corp. when I came across this interesting note:

"We have a Canadian subsidiary for which we elected to apply [the provisions of the American Jobs Creation Act] to qualifying earnings repatriations in fiscal year 2006. In January 2006, we executed a Domestic Repatriation Plan under the provision and repatriated $47.6 million, ......the net income tax benefit realized was $6.8 million, or $0.14 per diluted share for the fiscal year ended July 31, 2006."

I had forgotten about this tax loophole, which was created in Oct. 2004 when the American Jobs Creation Act, or AJCA, was signed into law. The loophole gives US companies a one-time 85 percent deduction on foreign earnings that are returned - or "repatriated" - to the US (through a dividend or otherwise). This translates into a 5.25 percent effective tax rate for those foreign earnings. Returned earnings must be reinvested in the U.S. under a "domestic repatriation plan" that the company's board of directors has approved. The condition: the reinvestment should be related to job friendly activities. That's it. Some loophole!

Until I saw the Zale's note, I hadn't thought of the potential impact the AJCA could have on Canada. After all, the law was touted primarily as a way to reverse the trend to outsourcing work overseas. But consider these facts: the current estimate is that a total of $350 billion of foreign income has been repatriated by US public and private companies. As the 2005 annual reports make their way to the public eyes, we're seeing part of the story unfold. A quick Google gives some indication that Canada's share of the repatriated cash drain may be significant: Ceridian repatriated $130 million from its Canadian subsidiary; Silgan - $64 million; Weyerhauser $1.1 billion.

When one looks at the high tech and life sciences sector, the potential impact of this one-time cash drain could be even more significant. For example, Pfizer reported that it would repatriate $37 billion from its worldwide operations back to the US. Mike Langberg of the San Jose Mercury News reviewed financial statements for the 20 largest public companies in Silicon Valley and found they alone had $28.7 billion in foreign profits brought to the United States: Hewlett-Packard-- $14.5 billion; Intel $6.2 billion; Oracle $3.1 billion; and Cisco Systems $1.2 billion. Repatriation was also popular with big tech companies outside the valley: IBM - $9.5 billion; Motorola $4.6 billion, Dell $4.1 billion and Microsoft $780 million.

My favourite VC once insisted (over lunch in Palo Alto) that Americans just don't say "you're welcome." I put this to the test by thanking our waitress profusely throughout the rest of the meal, and damn him if he wasn't right: all I got for my troubles was an "uh-huh," "you bet" and "sure." Maybe she sensed my insincerity, but still. Manners are manners.

It may be too early to tell what effect this cash drain will have on job creation in Canada. But it can't be good. However, since I am Canadian and my mom raised me right, let me just say to my American friends, you're welcome.

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