Punishing U.S. citizens who live outside the United States As Tax Residents Of Canada
"The Little Red Transition Tax Book" – Everything you need to know about the 965bmandatory repatriation tax but didn't know to ask. A horrific abuse of #Americansabroad in a @citizenshiptax and #FATCA world! https://t.co/j7v1Asreek
— U.S. Transition Tax – Subpart F and #GILTI (@USTransitionTax) June 26, 2023
The deadline for the submission of Amicus briefs in the Moore MRT appeal is rapidly approaching. As a result (partly by accident and partly by design) I have been rethinking a number of concepts including Subpart F generally, the 965 Transition Tax specifically, retroactivity in the context of the transition tax and (of course) the injustice inflicted by the U.S. “citizenship taxation” regime on dual Canada/US citizens who are resident in Canada. I just realized something that although obvious has not (to my knowledge) been discussed.
Bottom line: US citizens living in Canada who are subject to the 965 MRT AKA transition tax are (as individual shareholders of Canadian Controlled Private Corporations) subject to a tax that a U.S. citizen residing in the United States could NEVER be subject to!! Putting it another way: The U.S. citizen living in Canada is subject to a tax based on an activity (being a shareholder of a Canadian Controlled Private Corp) that a U.S. resident is not eligible to do. A U.S. citizen living in the United States is simply not eligible to be a shareholder of a Canadian Controlled Private Corporation that is a “Controlled Foreign Corporation”. A U.S. living in Canada is eligible to be a shareholder in a Canadian Controlled Private Corporation. Therefore, a Canadian resident is subject to the 965 transition tax with respect to a corporation that – vis-a-vis a U.S. resident – can never be a Controlled Foreign Corporation.
On the one hand this is clearly an abuse of U.S. citizens living in Canada (because of the U.S. citizenship tax regime) AND an attack on the Canadian tax base. On the other hand (as this post will demonstrate):
“It’s the American way!”
Part A – Prologue 1996: Treasury Creates The Legal Structure To Facilitate The 2017 Looting Of Canadian Controlled Private Corporations
America is obsessed with its corporations. The primary purpose of the 2017 TCJA was to lower the corporate tax rate from 35% to 21%. Individuals have a “love hate” relationship with Corporations. A country’s tax code is a reflection of the country’s values. The U.S. Internal Revenue Code has a hatred of “all things foreign”. But, nowhere is this hatred reflected more in the treatment of “foreign corporations” (think Subpart F, GILTI, transition tax and PFIC). Given the importance of corporations in U.S. culture and taxation, one would expect the Internal Revenue Code would define “corporation”. Shockingly it does not! The kinds of activities that are to be treated as corporations (unless there is an “opt out”) are defined NOT in the Internal Revenue Code, but in the Treasury Regulations – specifically the entity classification rules found in the 7701 entity classification regulations. These regulations were last subject to significant modification in 1996. The regulations created a class of entities that are called “**per se corporations”. A “per se corporation” is always treated as a “corporation”. This means that if they are “foreign corporations” they are always potentially subject to both the Subpart F and PFIC regimes. Notably almost ALL categories of Canadian corporations (including *Canadian Controlled Private Corporations) are treated as “per se” corporations. Because Canadian Controlled Private Corporations are deemed to be “per se corporations” they were “sitting ducks” for the 2017 TCJA changes – specifically GILT and the 965 Transition Tax.
In an earlier discussion how the 7701 Treasury entity classification regulations deemed Canadian Controlled Private Corporations to be “per se” corporations, I noted that:
Canadian corporations should NOT be deemed (under the Treasury entity classification regulations) to be “per se” corporations. The reality is that corporations play different roles in different tax and business cultures. Corporations in Canada have many uses and purposes, including operating as private pension plans for small business owners (including medical professionals).
Deeming Canadian corporations to be “per se” corporations means that they are always treated as “foreign corporations” for the purposes of US tax rules. This has resulted in their being treated as CFCs or as PFICs in circumstances which do not align with the purpose of the CFC and PFIC rules.
The 2017 965 Transition Tax confiscated the pensions of a large numbers of Canadian residents. The ongoing GILTI rules have made it very difficult for small business corporations to be used for their intended purposes in Canada.
Clearly Treasury deemed Canadian Controlled Private Corporations to be “per se” corporations without:
1. Understanding the use and role of these corporations in Canada; and
2. Assuming that ONLY US residents might be shareholders in Canadian corporations. As usual, the lives of US citizens living outside the United States were not considered.
These are the problems that inevitably arise under the US citizenship-based AKA extraterritorial tax regime, coupled with a lack of sensitivity to how these rules impact Americans abroad. The US citizenship-based AKA extraterritorial tax regime may be defined as:
The United States imposing worldwide taxation on the non-US source income of people who are tax residents of other countries and do not live in the United States!
It is imperative that the United States transition to a system of pure residence-based taxation!
Conclusion: The 1996 Treasury regulations deemed Canadian Controlled Private Corporations to be per se foreign corporations. Because they were deemed to be corporations this meant that they their “U.S. Shareholders” were subject to the Subpart F regime. Being subject to the Subpart F regime was both a necessary and sufficient condition for the 2017 looting of the retained earnings of those corporations through the 2017 965 MRT AKA transition tax.
Part B – The applicability of Subpart F, GILTI and the Transition Tax to “Canadian Controlled Private Corporations”
1. There are a number of different kinds of Canadian corporations. The overwhelming majority (I suspect 99%) of Canadian residents who are victims of the Subpart F regime (Subpart F generally, GILTI (in the future), Transition Tax (based on the past) are individual shareholders of Canadian Controlled Private Corporations. Canadian Controlled Private Corporations are used by “every day people” for various reasons (retirement planning, limited liability, etc.) They are typically small businesses and are used by individuals in every walk of life. For “every day” people, Canadian Controlled Private Corporations are “in effect” their pensions and retirement assets.
2. In order to qualify as a Canadian Controlled Private Corporation, the corporation CANNOT be “controlled directly or indirectly by one or more non-resident persons”. The corporation will be controlled by individuals who are “tax residents of Canada”. In fact, when a Canadian tax resident severs tax residency with Canada, their Canadian Controlled Private Corporation will no longer meet the necessary qualifications to maintain Canadian Controlled Private Corporation status. It is IMPOSSIBLE for U.S. residents to control more than 50% of a Canadian Controlled Private Corporation. A group of U.S. residents simply cannot control a Canadian Corporation and for that corporation to meet the requirements to be a Canadian Controlled Private Corporation.
3. The U.S Subpart F regime (including GILTI and the Transition Tax) can be applied ONLY to the shareholders of Canadian Controlled Private Corporation who are (1) residents of Canada and (2) who are U.S. citizens.
4. The application of the Subpart F regime to the individual shareholders of Canadian Controlled Private Corporations is a tax imposed ONLY on U.S. citizens who live outside the United States. It could not (in these circumstances) be imposed on U.S citizens living inside the United States. It is a tax that applies ONLY to U.S. citizens living in Canada and not on U.S. citizens living in the United States. (Your U.S. tax preparer is facilitating and enabling the payment of a tax that applies ONLY because the U.S. citizen lives in Canada! Ask your tax preparer what he/she thinks about their role in enabling transferring Canadian capital from Canada to the United States?)
5. Therefore, the United States is looting the earnings (past, present and future) of those Canadian Controlled Private Corporations owned by residents of Canada who are “U.S. Persons”. To put it simply: the fact of U.S. citizenship is being used to attack the tax base and tax policies of Canada.
6. It would make good sense for Canada to prohibit Canadian tax residents who are U.S. citizens (along with other possible prohibitions) from being shareholders of Canadian Controlled Private Corporations.
7. Subpart F was designed to prevent “U.S. Persons” (mainly multinational corporations and not individuals) from using foreign corporations to defer tax. It was not for the purpose of finding a new way to loot the earnings of Canadian Corporations because the shareholders are Canada/US dual citizens who live in Canada.
Canadian-controlled private corporation (CCPC)
The corporation is a CCPC if it meets all of the following requirements at the end of the tax year:
it is a private corporation
it is a corporation that was resident in Canada and was either incorporated in Canada or resident in Canada from June 18, 1971, to the end of the tax year
it is not controlled directly or indirectly by one or more non-resident persons
it is not controlled directly or indirectly by one or more public corporations (other than a prescribed venture capital corporation, as defined in Regulation 6700 of the Income Tax Regulations)
it is not controlled by a Canadian resident corporation that lists its shares on a designated stock exchange outside of Canada
it is not controlled directly or indirectly by any combination of persons described in the three previous conditions
if all of its shares that are owned by a non-resident person, by a public corporation (other than a prescribed venture capital corporation), or by a corporation with a class of shares listed on a designated stock exchange were owned by one person, that person would not own sufficient shares to control the corporation
no class of its shares of capital stock is listed on a designated stock exchange
**Appendix B – Foreign Corporations treated as “per se” corporations under the entity classification regulations
American Samoa, Corporation
Argentina, Sociedad Anonima
Australia, Public Limited Company
Barbados, Limited Company
Belgium, Societe Anonyme
Belize, Public Limited Company
Bolivia, Sociedad Anonima
Brazil, Sociedade Anonima
Bulgaria, Aktsionerno Druzhestvo.
Canada, Corporation and Company
Chile, Sociedad Anonima
People’s Republic of China, Gufen Youxian Gongsi
Republic of China (Taiwan), Ku-fen Yu-hsien Kung-szu
Colombia, Sociedad Anonima
Costa Rica, Sociedad Anonima
Cyprus, Public Limited Company
Czech Republic, Akciova Spolecnost
Ecuador, Sociedad Anonima or Compania Anonima
Egypt, Sharikat Al-Mossahamah
El Salvador, Sociedad Anonima
European Economic Area/European Union, Societas Europaea
Finland, Julkinen Osakeyhtio/Publikt Aktiebolag
France, Societe Anonyme
Greece, Anonymos Etairia
Guatemala, Sociedad Anonima
Guyana, Public Limited Company
Honduras, Sociedad Anonima
Hong Kong, Public Limited Company
India, Public Limited Company
Indonesia, Perseroan Terbuka
Ireland, Public Limited Company
Israel, Public Limited Company
Italy, Societa per Azioni
Jamaica, Public Limited Company
Japan, Kabushiki Kaisha
Kazakstan, Ashyk Aktsionerlik Kogham
Republic of Korea, Chusik Hoesa
Latvia, Akciju Sabiedriba
Lithuania, Akcine Bendroves
Luxembourg, Societe Anonyme
Malta, Public Limited Company
Mexico, Sociedad Anonima
Morocco, Societe Anonyme
Netherlands, Naamloze Vennootschap
New Zealand, Limited Company
Nicaragua, Compania Anonima
Nigeria, Public Limited Company
Northern Mariana Islands, Corporation
Norway, Allment Aksjeselskap
Pakistan, Public Limited Company
Panama, Sociedad Anonima
Paraguay, Sociedad Anonima
Peru, Sociedad Anonima
Philippines, Stock Corporation
Poland, Spolka Akcyjna
Portugal, Sociedade Anonima
Puerto Rico, Corporation
Romania, Societate pe Actiuni
Russia, Otkrytoye Aktsionernoy Obshchestvo
Saudi Arabia, Sharikat Al-Mossahamah
Singapore, Public Limited Company
Slovak Republic, Akciova Spolocnost
Slovenia, Delniska Druzba
South Africa, Public Limited Company
Spain, Sociedad Anonima
Surinam, Naamloze Vennootschap
Sweden, Publika Aktiebolag
Thailand, Borisat Chamkad (Mahachon)
Trinidad and Tobago, Limited Company
Tunisia, Societe Anonyme
Turkey, Anonim Sirket
Ukraine, Aktsionerne Tovaristvo Vidkritogo Tipu
United Kingdom, Public Limited Company
United States Virgin Islands, Corporation
Uruguay, Sociedad Anonima
Venezuela, Sociedad Anonima or Compania Anonima
(ii) Clarification of list of corporations in paragraph (b)(8)(i) of this section—(A) Exceptions in certain cases. The following entities will not be treated as corporations under paragraph (b)(8)(i) of this section:
(1) With regard to Canada, a Nova Scotia Unlimited Liability Company (or any other company or corporation all of whose owners have unlimited liability pursuant to federal or provincial law).