FedEx Earnings Reversal Exposes Need for Final Repatriation Rules

Confusion about pending U.S. tax regulations is bringing volatility where multinationals want it least: earnings reports.

When companies give quarterly updates to their investors, they aim to give a snapshot of their financial footing. But a lag between deadlines for Securities and Exchange Commission filings and the IRS’s expected final rules on accumulated foreign earnings means companies are announcing tax liabilities and benefits they may need to change later.

In the first of what could be a flood, FedEx Corp. told investors in a Sept. 17 quarterly earnings report it may have to reverse a previously reported $225 million benefit if the Treasury Department finalizes the repatriation tax rules —also known as the transition tax—as proposed in August.

“It’s tough for investors because what else do they have to rely on but SEC filings to make correct estimates in their financial statements? What else do shareholders have?” Andrew Silverman, a Bloomberg Intelligence tax policy analyst, told Bloomberg Tax.

Under Internal Revenue Service proposed rules (REG-104226-18), U.S.-based companies must pay tax on the estimated $3 trillion they’ve stashed abroad since 1986. Final rules will tell companies how to determine what tax rate applies to which assets, how tax credits can be applied, and how to sort payments from controlled foreign corporations. But until the IRS issues those rules, companies are left guessing on quarterly earnings reports—and investors should be wary.

“Companies are caught in the middle of following the SEC rules and waiting on IRS rules—and that is what put FedEx in that situation,” Silverman said.

Here are three ways the proposed repatriation tax rules could impact earnings reports.

1. Reversal of Tax Positions

Companies are taking tax positions contrary to the proposed guidelines and calculating earnings from those figures, practitioners said.

“This could cause a lot of volatility in the market if investors take these numbers at face value and put them into their models. Companies don’t necessarily have a basis for these tax positions,” Silverman said.

The IRS and Treasury proposed “incomplete” rules Aug. 1 on how to determine which assets fall into the 15.5 percent or 8 percent tax buckets—assessed on cash or illiquid assets, respectively—but haven’t yet issued guidance on how returns should be filed. This leaves companies “essentially looking at a blank page” while calculating the tax on 30 years of overseas profits due Oct. 15.

“Over a year, the IRS has been releasing notices and FAQs that potentially change the calculations you’d completed based on the last notice, and that can impact decisions and analysis,” Cory Perry, senior manager of international tax at Grant Thornton LLP’s Washington National Tax Office, told Bloomberg Tax.

Perry’s clients have been unhappy with conservative tax advice based on the proposed regulations and are instead reporting tax positions that contradict what the Treasury Department has said so far.

But those tax positions could be reflective of what companies want to show investors, rather than the reality of what the Treasury will finalize, practitioners said.

“The majority of the time, what’s in the proposed regulations carries through to the final,” Robert Russell, director of international tax at Alliantgroup LP, who formerly worked at the IRS and Treasury, told Bloomberg Tax.

2. Penalty Problems

The stakes are high for companies that misreport taxes to the IRS.

The IRS generally has three years after a tax return is filed to assess any additional tax, but the amended code Section 6501(c)(8) opens that window indefinitely in cases of false or fraudulent returns.

When a company is preparing for a possible IRS collection, it has to write that into its financial statements, Perry said. “So effectively you’re reporting exposure and it’s impacting overall earnings.”

Tax practitioners are calling the penalties under tax code Section 965 “a tightrope” and say they contradict the intent of the repatriation tax, which was pitched as a bridge to drive overseas profits back into the U.S.

Taxpayers are running out of time to get it right, he said. The deadline to file pass-through returns deadline was Sept. 15, and corporate or individual returns are due Oct. 15.

A mistake could result in a $10,000 fine per error, the eight-year payment window being closed, or the IRS delaying unrelated tax refunds for the purpose of fulfilling the repatriation tax obligation—a Catch-22 for companies attempting to avoid penalties.

Companies typically make conservative tax estimates to avoid penalties, but holding back refunds to cover an unrelated tax is penalizing in itself, according to John Harrington, a partner at Dentons in Washington and chair of the Bloomberg Tax International Advisory Board.

“Companies have spoken out about this rule but the IRS is not backing off,” Harrington said.

3. Earnings Quality

Neither companies nor the IRS wants to take responsibility for the confusion or for its impact on the quality of earnings reports, practitioners said.

“This wasn’t something companies saw coming—there is an element of surprise in terms of the size of the tax liability and the speed by which the rules were developed,” Harrington said.

For multinationals reporting taxes for hundreds of overseas entities the challenges are “significant and expensive,” because companies have had only a year to adapt to the new tax rules, practitioners said.

“But then companies like FedEx are pointing the finger back at the IRS,” Silverman said.

The IRS has put out more guidance on the repatriation tax than any other rules, and while it’s still not enough to answer everyone’s questions about the tax, it is enough for the IRS to put the burden of certainty back on companies, Silverman said.

“I predict by the end of the year, companies will have to make changes to their financial statements in some material ways because they’ve taken tax positions in incorrect ways,” Silverman said.

“It’s tough for investors because they have nothing else to rely on but SEC filings to make correct estimates,” he said.