Tax Break for outsourcing AJCA 2004

President Barak Obama has just signed the stimulus Package. One point discussed in the recent legislation has caused extreme concern. This is the removal in Tax breaks for “outsourcing”.

Before going to details I would like to quote Russell Baker.

“An educated person is one who has learned that information almost always turns out to be at best incomplete and very often false, misleading, fictitious, mendacious - just dead wrong.”

There is a fear around the repeal of the tax break for companies outsourcing their work. The first question is was there ever any specific tax break for companies outsourcing their work? And how affected will companies be when the tax bar is raised from 5.25% to 35%.

To answer the first question, no there was never actually any specific law related to outsourcing. What had come about in 2004, many years after outsourcing actually began was a tax holiday to encourage American Companies to repatriate their funds from Overseas, back to the US, under the bill, the "American Jobs Creation Act (AJCA) of 2004. Under US Tax law, overseas subsidiaries have no specific time limit on the repatriation of funds. So they can keep the profits made outside the US indefinitely. In 2004, to encourage companies to bring back their profits, Congress gave a tax holiday and reduced the corporate tax from 35% to 5.25%.

This enabled companies to bring back $360 billion stashed outside. Interestingly about 75% came from low tax areas like the Netherlands and other European countries and Tax havens like Cayman Islands and Bermuda. Also a lot of the profits were from the pharma companies.

It is a misnomer that companies make profits solely by outsourcing. A lot of them are engaged in legitimate business activities like Coke and Pepsi are in the soft drinks business or HP and Dell selling computer products and services. This step might actually hurt legitimate operations of US multinationals making them less efficient.

To answer the second question, repealing the tax break will not necessarily affect outsourcing or increase its cost. This is apparent as these companies are currently not bound to repatriate their profits in a specific time frame. Even if they were, one advantage parent companies have with their subsidiaries is that they can decide how much profits are to be booked under transfer pricing.

In another scenario, if a US multinational outsourced its work to a third party, the profits it made by cost savings was being taxed at the same amount of 35% in any case, so how can we say that a tax break has been removed and outsourcing will become costlier?