Part 5: Responding to the Sec. 965 “transition tax”: Shades of #OVDP! April 15/18 is your last, best chance to comply!

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Introduction
This is the fifth in my series of posts about the Sec. 965 Transition Tax and whether/how it applies to the small business corporations owned by tax paying residents of other countries (who may also have U.S. citizenship). These small business corporations are in no way “foreign”. They are certainly “local” to the resident of another country who just happens to have the misfortune of being a U.S. citizen.
The purpose of this post is to argue that (as applied to those who do not live in the United States) the transition tax is very similar to the OVDP (“Offshore Voluntary Disclosure Programs”) which are discussed here. Some of my initial thoughts (December 2017) were captured in the post referenced in the following tweet:


The first four posts in my “transition tax” series were:
Part 1: Responding to The Section 965 “transition tax”: “Resistance is futile” but “Compliance is impossible”
Part 2: Responding to The Section 965 “transition tax”: Is “resistance futile”? The possible use of the Canada U.S. tax treaty to defeat the “transition tax”
Part 3: Responding to the Sec. 965 “transition tax”: They hate you for (and want) your pensions!
Part 4: Responding to the Sec. 965 “transition tax”: Comparing the treatment of “Homeland Americans” to the treatment of “nonresidents”
*A review of what what the “transition tax” actually is may be found at the bottom of this post.
This post is for the purpose of the arguing that, as applied to those who live outside the United States, payment of the “transition tax” in 2018, is the financial equivalent to participation in 2011 OVDI (“Offshore Voluntary Disclosure Program”).
 


Seven Reasons Why The U.S. Transition Tax as applied to “nonresidents” is similar to the “Offshore Voluntary Disclosure Program As Applied To “Nonresidents”. In both cases there are benefits to Homeland Americans and extreme detriments to “nonresidents”. These detriments amount to a punishment for living outside the United States and becoming a “tax resident” of another country.

Reason 1: Both the U.S. Transition Tax and the “Offshore Voluntary Disclosure Programs” were based on a payment of the percentage of assets and NOT on a “realization event”.
In the case of OVDP, the penalty was based on a percentage of the value of assets what were used to generate income.
In the case of the “transition tax”, a payment is demanded based on a percentage of the “retained earnings” of the company (which exist to earn income).
In neither case is the payment based on a specific “realization event”. In other words, most instances of taxation are levied on a purchase or a sale. In this cases of “OVDP” and the “transition tax”,  the payment is demanded based simply on the fact that the asset (pool of capital exists).
Both “OVDP” and the “transition tax” operate on the:

“Oh my God,” “we see capital assets”. “Turn a percentage of them over”, principle!

We are going to seize those assets!

For this reason, both the “transition tax” and OVDP are/were “wealth extractions” that operate more like “confiscations of capital” rather than taxation based on a “realization event“.
Reason 2: Both the “transition tax” and the OVDP programs are/were, when applied to “nonresidents”, the confiscation of wealth that actually belongs to another country.**
In both cases, the “programs” result in the confiscation of assets over which the “nonresident’s country of residence” has primary taxing jurisdiction. For example, Canada has primary taxing jurisdiction over Canadian Controlled Private Corporations. This principle is explicitly recognized in Section 5 of Article X of the Canada U.S. Tax Treaty which specifically prohibits the United States from imposing taxation on the “undistributed earnings” of Canadian corporations. The whole purpose of the “transition tax” is to impose U.S. taxation on the “undistributed earnings” of Canadian corporations.
As the tax treaty states:

5. Where a company is a resident of a Contracting State, the other Contracting State may not impose any tax on the dividends paid by the company, except insofar as such dividends are paid to a resident of that other State or insofar as the holding in respect of which the dividends are paid is effectively connected with a permanent establishment or a fixed base situated in that other State, nor subject the company’s undistributed profits to a tax, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State.

Reason 3: Both the “transition tax” and OVDP are programs that benefit Homeland Americans AND are incredibly destructive to “nonresidents” (Americans abroad)
For long term Americans abroad, most of their assets are located outside the United States would be considered (from a U.S. perspective) to be “foreign”. For Homeland Americans a much smaller percentage of their assets would likely be “foreign”. Under “OVDP” a higher percentage of the “assets” of Americans abroad would be subject to the penalty base.
Americans abroad would create corporations that are local to them, but “foreign” to the United States. Homeland Americans creating “non-U.S. corporations” really are creating corporations that are foreign to them. Americans abroad are creating corporations in countries where are “tax resident”. Homeland Americans, who use “foreign corporations” are creating corporations where they are NOT “tax resident”.
For long term Americans abroad, their “foreign assets” were almost certainly “after tax” assets accumulated in their country of residence. For Homeland Americans their “foreign assets” were more likely to have been used to avoid taxes.
Conclusion: Although Americans abroad were more likely to be innocent, they were likely to pay a higher price to participate in OVDP, than a Homeland American. As previously discussed, the “transition tax” is a benefit to Homeland Americans but an instrument of “pension confiscation” for Americans abroad. A Homeland American who creates a “local corporation” is NOT subject to any kind of “transition tax”. A “nonresident” who creates a “local corporation” (which is “foreign to the United States) is creating a corporation that is subject to the “transition tax”.
Reason 4: For Americans abroad both the “transition tax” and OVDP operate primarily as pension confiscations.
For many nonresidents, the retained earnings in their small corporations are considered to be their pensions. They represent a lifetime of work, savings and labor. Entrepreneurs do not typically have the “private pension plans” available to certain kinds of “salaried employees”.
In the same way that (for Americans abroad) the “OVDP” program confiscated “after tax paid” assets owned by Americans abroad, the “transition tax” is confiscating after tax paid capital that operates as a private pension plan.
Both the “transition tax” and “OVDP” confiscate assets that are regarded as the “pension plans” of their owners.
Reason 5: In both cases it is difficult to find competent professional advice concerning how the program/statute works and what the terms of the program/statute really are.
During the 2011 “OVDI” panic it was very difficult to find competent professional help that could help one understand, evaluate and estimate the costs of participation in the program.
During 2018 it is very difficult to find professionals that are competent to help you understand how the “transition tax” works and possible offsets.
Looking for help with “transition tax”? Good luck to you!

Reason 6: Both the “OVDP” programs and the “transition tax” come with very very significant compliance costs!
If you are able to find someone to assist you with “transition tax” compliance, it will come with very high professional fees. For the “transition tax” the issues include (but are not limited to):
– how much income is subject to the “transition tax”?
– of the included income, what is the ratio of “cash” to “fixed” assets?
– what is the total tax owing?
– how is this tax to be paid? By using tax credits from Canada (either personal or corporate)? By paying the tax without the advantage of “tax credits”?
– does the installment option make sense?
– etc.
If you were able to find someone to help you with “OVDP” compliance the professional fees could easily have been six figures.
Think of it: participants in the “OVDP” and “transition tax” programs are paying huge professional fees to commit financial suicide!
Reason 7: Both the 2009 and 2011 OVDP programs came with “This is your last best chance to come into compliance” deadlines. Interestingly, the “transition tax” comes with a close “payment deadline” that works like this:


By April 15 you must agree to turn approximately 20% of the value of your company to the U.S. Government. If you do agree to this by April 15, 2018 you can stretch the payment over 8 years. If you do NOT agree to pay by April 15, 2018 you CANNOT stretch the payment over 8 years.
In other words:
April 15, 2018 is  your last best chance to come into compliance!!! Does this sound familiar?
But, just hold on a minute! How are “OVDP” and the “transition tax” different?
OVDP is different from the “transition tax” because OVDP was “voluntary” and the “transition tax” is mandatory.
One wonders:
Does the end of #OVDP signal a move FROM the “voluntary disclosure” model TO the “enforcement model (calling it a tax)”?
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*As a reminder, as explained in this comment, the essential characteristics of the Sec. 965 “transition tax” as applied to the residents of other countries include:

Interesting article that demonstrates the impact of the U.S. tax policy of (1) exporting the Internal Revenue Code to other countries and (2) using the Internal Revenue Code to impose direct taxation on the “tax residents” of those other countries.
Some thoughts on this:
1. Different countries have different “cultures” of financial planning and carrying on businesses. The U.S. tax culture is such that an individual carrying on a business through a corporation is considered to be a “presumptive tax cheat”. This is NOT so in other countries. For example, in Canada (and other countries), it is normal for people to use small business corporations to both carry on business and create private pension plans. So, the first point that must be understood is that (if this tax applies) it is in effect a “tax” (actually it’s confiscation) of private pension plans!!! That’s what it actually is. The suggestion in one of the comments that these corporations were created to somehow avoid “self-employment” tax (although possibly true in countries that don’t have totalization agreements) is generally incorrect. I suspect that the largest number of people affected by this are in Canada and the U.K. which are countries which do have “totalization agreements”.
2. None of the people interviewed, made the point (or at least it was not reported) that this “tax” as applied to individuals is actually higher than the “tax” as applied to corporations. In the case of individuals the tax would be about 17.5% and not the 15.5% for corporations. (And individuals do not get the benefit of a transition to “territorial taxation”.)
3. As Mr. Bruce notes people will not easily be able to pay this. There is no realization event whatsoever. It’s just: (“Hey, we see there is some money there, let’s take it). Because there is no realization event, this should be viewed as an “asset confiscation” and not as a “tax”.
4. Understand that this is a pool of capital that was NEVER subject to U.S. taxation on the past. Therefore, if this is a tax at all, it should be viewed as a “retroactive tax”.
5. Under general principles of law, common sense and morality (does any of this matter?) the retained earnings of non-U.S. corporations are first subject to taxation by the country of incorporation. The U.S. “transition tax” is the creation of a “fictitious taxable event” which results in a preemptive “tax strike” against the tax base of other countries. If this is allowed under tax treaties, it’s only because when the treaties were signed, nobody could have imagined anything this outrageous.
6. It is obvious that this was NEVER INTENDED TO APPLY TO Americans abroad. Furthermore, no individual would even imagine that this could apply to them without “Education provided by the tax compliance industry”. Those in the industry should figure out how to argue that this was never intended to apply to Americans abroad, that there is no suggestion from the IRS that this applies to Americans abroad, that there is no legislative history suggesting that this applies to Americans abroad, and that this should not be applied to Americans abroad.
7. Finally, the title of this article refers to “Americans abroad”. This is a gross misstatement of the reality. The problem is that these (so called) “Americans abroad” are primarily the citizens and “tax residents” of other countries – that just happen to have been born in the United States. They have no connection to the USA. Are these citizen/residents of other countries (many who don’t even identify as Americans) expected to simply “turn over” their retirement plans to the IRS???? Come on!
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**This demonstrates why Canada’s FATCA IGA with the United States works against Canada’s national interests. Pursuant to the IGA, Canada agreed to change its laws to require Canadian financial institutions to “hunt” for those Canadian Controlled Private Corporations that had “U.S. Person” ownership. Once located, this information would be turned over to the IRS. Pursuant to the “transition tax” the United States is now trying to confiscate a percentage of the value of those Canadian Corporations.
To put it simply:
1. First, use FATCA to locate corporations that are owned by Canadians who are also “U.S. persons”.
2. Second, use the “transition tax” to confiscate a share of the assets.
So, simple really.
Yet, the Government of Canada is vigorously defending their right to do this in the lawsuit initiated by the Alliance For The Defense of Canadian Sovereignty.
 

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