Americans abroad who are individual shareholders of small business corporations in their country of residence have been very negatively impacted by the Section 951A GILTI and Section 965 TCJA amendments. In June of 2019, by regulation, Treasury interpreted the 951A GILTI rules to NOT apply to active business income when the effective foreign corporate tax rate was at a rate of 18.9% or higher. Treasury’s interpretation was reasonable, consistent with the history of Subpart F and consistent with the purpose of the GILTI rules.
Now, Senators Wyden and Brown are attempting to reverse Treasury’s regulation through legislation. This is a direct attack on Americans abroad. Senators Wyden and Brown are living proof of the principle that:
When it comes to Americans abroad:
It’s not that Congress doesn’t care. It’s that they don’t care that they don’t care!
As many readers will know the 2017 US Tax Reform, referred to as the Tax Cuts and Jobs Act (TCJA), contained provisions which have made it difficult for Americans abroad to run small businesses outside the United States. In the common law world a corporation is treated as a separate legal entity for tax purposes. In other words the corporation and the shareholders are separate for tax purposes, file separate tax returns and pay tax on different streams of income. The 2017 TCJA contained two provisions that basically ended the separation of the company and the individual for U.S. tax purposes. In other words: there is now a presumption (at least how the Internal Revenue Code applies to small business owners) that active business income earned by the corporation will be deemed to have been earned by the individual “U.S. Shareholders”. To put it another way: individual shareholders are now presumptively taxed on income earned by the corporation, whether the income is paid out to the shareholders or not! The effect of this on individual Americans abroad has been discussed by Dr. Karen Alpert in her article: “Callous Neglect: The impact of United States tax reform on nonresident citizens“.
The expansion of the Subpart F Regime
The Subpart F rules were established in 1962. The principle behind them was that individual Americans should be prevented from, using foreign corporations to earn passive income, in jurisdictions with low tax regimes (or tax regimes that have lower taxes than those imposed by the United States). The Subpart F rules have (since 1986) included a provision to the effect that investment income (earned inside a foreign corporation) which was subject to foreign taxation at a rate of 90% or more of the U.S. corporate rate, would NOT be subject to taxation in the hands of the individual shareholder.
To put it another way (with respect to investment income):
1. It was mostly investment/passive income that was subject to inclusion in the incomes of individual shareholders as Subpart F income; and
2. Passive income that was subject to foreign taxation at a rate of 90% or more of the U.S. corporate tax rate (now 21%) would NOT be considered to be Subpart F income (and therefore not subject to inclusion in the hands of individual shareholders).
To coordinate my background discussion with the Arnold Porter submission described below, I will refer to exclusion of investment income subject to a 90% tax rate as “HTKO” (High Tax Kick Out).
The basic principle was (and continues to be):
If passive income earned in a foreign corporation is taxed at a rate of 90% or more of the U.S. corporate tax rate, that there was no attribution of that corporate income to the individual U.S. shareholder.
In its most simple terms, the Subpart F rules are found in Sections 951 – 965 of the Internal Revenue Code. They are designed to attribute income earned by the corporation directly to the U.S. shareholder, without regard to whether the corporate profits were paid to the shareholders as a dividend. Note that many developed countries have similar rules. Many developing (from a tax perspective) countries (for example Russia) are adopting Subpart F type rules. The U.S. rules are more complicated, more robust and (because of citizenship taxation) apply to the locally owned companies of individuals, who do not live in the United States.
Punishing them for their past and destroying their futures – The expansion of the Subpart F Regime to active business income