Introduction and background …

“This legislation is being interpreted by a number of tax professionals to mean that individual U.S. citizens living outside the United States are required to simply “fork over” a percentage of the value of their small business corporations to the IRS. Although technically “CFCs” these companies are certainly NOT foreign to the people who use them to run businesses that are local to their country of residence. Furthermore, the “culture” of Canadian Controlled Private Corporations is that they are actually used as “private pension plans”. So, an unintended consequence of the Tax Cuts Jobs Act would be that individuals living in Canada are somehow required to collapse their pension plans and turn the proceeds over to the U.S. government” -John Richardson

I have previously suggested that the Section 965 “transition tax” should not be interpreted to apply to Americans abroad. This argument was based largely on a “lack of legislative intention” coupled with the fact that individuals (whether in the USA or living abroad) do NOT get the benefits of the transition to “territorial taxation”.
These are difficult times for many Canadians who are the owners of Canadian Controlled Private Corporations. Canadian residents use Canadian Controlled Private Corporations (“CCPCs”) to operate small businesses and to create pension plans for their retirement. Importantly a Canadian corporation meets the definition of a “CCPC” only if it is controlled by residents of Canada. By definition all “CCPCs” are local to their owners. The use of “CCPCs” reflects the reality of Canadian tax laws going back to 1972. Governments the world over are taking steps to ensure that corporations cannot be used for the deferral or avoidance of taxation.
The election of the Trudeau Liberals resulted in the Government of Canada taking an interest in “Tax Reform” (or at least “tax reform” in relation to Canadian Controlled Private Corporations). On February 27, 2018 Finance Minister Morneau delivered the Liberals third budget. Although not widely publicized, the budget including major changes in how the passive income of CCPCs is to be taxed in Canada.
Of course those “CCPC” owners who have U.S. citizenship must also deal with the U.S. tax system. Interestingly, both the Government of Canada and the Government of the United States have the owners of “CCPCs” on their radar.
Canada – On the “Home front” (meaning in Canada) the Liberal Government of Justin Trudeau and Finance Minister Bill Morneau are targeting the “retained earnings” in their corporations. Specifically they believe that “retained earnings” that were subject to the lower small business tax rate provide an unfair tax deferral, resulting in more capital to invest, which allows for the creation of additional passive income. The February 27, 2018 Canadian budget is a direct response to this perception.
The United States – The “Homeland” has just passed the TCJA (“Tax Cuts Jobs Act”). One provision of the TCJA amended Internal Revenue Code Section 965 to impose a one time tax on the “United States shareholders” of “Deferred Foreign Income Corporations” (a “DFIC”). This tax is based on the “undistributed earnings” of corporations. The application of this tax to U.S. citizens living outside the United States is newsworthy, is debatable (and is being debated). The application of the Section 965 “transition tax (assuming the applicability of the tax to Canadian resident owners of “CCPcs”), would be a direct, retroactive tax on the “retained earnings” of Canadian Controlled Private Corporations. Notably these “retained earnings” were NEVER subject to U.S. taxation before (it’s retroactive). The mechanism that the U.S. Government is using to impose direct taxation on the retained earnings of “CCPCs” is to (1) attribute the corporate undistributed earnings to the individual shareholder and (2) impose taxation directly on the individual shareholder. For “Tax Geeks” (and those who want boring cocktail conversation), from a U.S. perspective this process of income attribution is called “Subpart F” income. (You can learn all about it by reading Internal Revenue Code Sections 951 – 965). I emphasize that a Subpart F inclusion (by definition) attributes corporate income to a “shareholder” without any realization event whatsoever.
Continue reading →