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”