Tag Archives: U.S. transition tax

Part 8: Responding to the Sec. 965 “transition tax”: This small business thought it was saving to invest in business expansion – Wrong, they were saving to be robbed by America!

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This is the eighth in my series of posts about the Sec. 965 Transition Tax and whether/how it applies to the small business corporations owned by taxpaying 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.
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Part 7: Responding to the Sec. 965 “transition tax”: Why the transition tax creates a fictional tax event that allows the U.S. to collect tax where it never could have before

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Introduction

This is the seventh in my series of posts about the Sec. 965 Transition Tax and whether/how it applies to the small business corporations owned by taxpaying 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.

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Part 6: Responding to the Sec. 965 “transition tax”: A "reprieve" until June 15, 2018

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Introduction
This is the sixth 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.
This post will draw on the lessons/discussion from the first five posts. The specific purpose of this post is to argue that what the United States calls “taxation” (presumably because it is found in the Internal Revenue Code), as applied to “nonresidents” is actually a separate tax regime that:
1. Imposes different tax rules on “nonresidents” (certain individuals who live outside the United States); and
2. Those rules for “nonresidents” are designed to operate primarily as “confiscations of non-U.S. assets.
The Internal Revenue Code of the United States is based on three principles:
Principle 1: A hatred for all things foreign
Principle 2: A hatred of all forms of deferral (except IRAs, 401Ks and other U.S. sanctioned forms of deferral)
Principle 3: Attempts of prevent “leakage” of “U.S. person” owned assets from the U.S. tax system.
The interaction of these three principles creates a complex, penalty laden, “anti-deferral regime”, that specifically targets income and assets earned in other countries and located in other countries.
The time has come for countries who have U.S. tax treaties that contain the “savings clause” and which have signed to FATCA IGAs to “wake up” to this reality.
To put it simply: What the U.S. calls “taxation” is actually the “confiscation” of assets located in other countries. The “transition tax” is a timely and exceptionally brazen example of how this confiscation works.
The first five 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”
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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Part 1: Responding to The Section 965 "transition tax": "Resistance is futile" but "Compliance is impossible"

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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.
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Americans abroad opposing "taxation-based citizenship" should retire the "Taxation Without Representation" argument

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In a recent comment reproduced as a post at the Isaac Brock Society and at Citizenship Taxation, I argued that it’s time for people to unite with one simple message. The message captured in the following tweet:


“The United States must not impose “worldwide taxation” on those who have “tax residency” in other countries and do not live in the United States!”
I propose this for the following reasons:
1. There is not a single person or organization on the planet that could not support this and credibly claim that they want to end U.S. extra-territorial tax policies.
2. It places the focus of U.S. tax policies on how the policies affect the citizens and residents of other countries and NOT on those who identify as U.S. citizens living abroad AKA “Homelanders Abroad”. There is no suggestion of seeking exemptions for certain “tax compliant people”, …
3. It resonates with “accidentals” (AKA those carbon life forms that the United States considers to be life long tax slaves) because they were born in the United States.
4. It naturally leads to a discussion of how U.S. extra-territorial taxation affects the economies (“steals from their tax base) of other countries.
5. By focusing on “tax residents” of other countries, it avoids alltogether the idiotic “baff gablle” of: “Well, you are a member of the political community”, “patriotism”, “right to live in the USA” and all of these “academically focussed) distractions.
6. It avoids getting into the incredibly difficulty problem of explaining precisely HOW the Internal Revenue Code applies in different countries (in practical terms it applies differently in different countries). Almost nobody understands how the Internal Revenue Code actually applies in other countries (including the IRS) …
7. It bypasses arguments like: “What do you mean you are complaining? I hear you exclude about 100,000 using this thing called the “Foreign Earned Income Exclusion”. If you can exclude 100,000 when you don’t even live in the USA, then why can’t I as a Homelander exclude at least 100,000″ …
Again to agree to the message:
“The United States must not impose “worldwide taxation” on those who have “tax residency” in other countries and do not live in the United States!”
should avoid the distractions described in points 1 – 7.
“Taxation without representation argument”
But, I want to focus on an argument/point that I think is a particular time waster and probably hurts the cause rather than helps it.
The ONLY Americans who have representation in the political process are those who have the money to “buy the laws” that they want. The American legislative process is nothing more and nothing less than a “pay to play casino”. It’s that simple. America is one of the world’s most dysfunctional democracies. In fact it is a democracy only in the sense that some Americans (including some but not all Americans abroad) have the right to vote. Having a vote is a necessary but not a sufficient condition for a functioning democracy. A vote matters only if there are viable candidates to vote for. In the America of today, who the candidates are, is tightly controlled by the political parties. Do you really think that if America had a functioning democracy, that allowed for democratically selected candidates, that the 2016 election would have come down to:
Donald Trump vs. Hilary Clinton?
Not a chance. My point is that almost no Americans have political representation in any case. By making the “taxation without representation argument”, Americans abroad are asking for something that Homelanders don’t have!

So, please let’s retire the:

“Taxation without representation argument”!
John Richardson
My morning thoughts on this were generated by the comments in the following tweets (all of which were generated by the Financial Times discussion on the Sec. 965 Transition Tax:

U.S. Tax Reform and the "nonresident" corporation owner: Does the Sec. 965 transition tax apply?

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Prologue:
The United States has a long history of imposing “worldwide taxation”on the INDIVIDUAL “tax residents” of other countries. The United States cannot impose direct taxation on “non-U.S corporations” that have no business connection to the United States. That said, the United States (along with certain other countries) has “CFC” (Controlled Foreign Corporation) rules that impose taxation on the “United States Shareholders” of “non-U.S. corporations. In general, these rules simply attribute certain types of corporate income directly to the individual “United States Shareholder”.
U.S. Tax Reform 2017 (well at least “International Tax Reform”)
In early November 2017, it appeared that U.S tax reform “might” include a provision that would in effect impose retroactive taxation on the retained earnings of Canadian (and other non-U.S.) small business corporations. I wrote about that here.
On December 22, 2017 President Donald Trump signed into law the “Tax Cuts and Jobs Act”. The uniquely U.S. policy of imposing “worldwide taxation” on the tax residents and citizens of other countries continues. FATCA continues. In other words, in spite of the educational campaign orchestrated by individuals and groups (Americans Citizens abroad and Republicans Overseas) the U.S. Government (although aware of the aware of the problems) declined to make the changes necessary to allow U.S. citizens to live normal financial lives outside the United States. An earlier post, describing “How U.S. Citizens Can Live Abroad In An FBAR and FATCA World” demonstrates that the rules of the Internal Revenue Code involve far more than taxation, but include a number of “penalty laden, intrusive information reporting requirements”. Significantly these rules impact people who are resident/citizens of other countries who are subject to the tax systems of those countries. Many of those impacted do not even consider themselves to be U.S. citizens. Some of them don’t even speak English. Few of them can afford the expensive compliance costs. How could things get worse?
Well, it is possible (but not certain) that things have gotten worse. Incredibly there are some people impacted by U.S. tax rules who are “tax residents” of other countries AND have made the decision to create small businesses where they live. Furthermore, some of them have opted to carry on those businesses by creating “local corporations”. In Canada these “local corporations” are called “Canadian Controlled Private Corporations”. Every country has its own “culture of corporations”. In Canada (to the chagrin of Prime Minister Trudeau and Finance Minister Morneau) these corporations are used as “private pension plans”. (This is because entrepreneurs rarely have access to other traditional pension plans.)
So, what does all this have to do with U.S. tax?
1. The U.S. Internal Revenue Code cannot impose direct taxation on Canadian (or other foreign) corporations.
2. As a result, the U.S. Internal Revenue Code has traditionally attributed the “passive earnings” of many “Canadian Controlled Private Corporations”, to the individual “United States Shareholder”. (See Subpart F: Sections 951 – 965 of the Internal Revenue Code – you have no chance of understanding the legislative scheme.)
3. The Internal Revenue Code has NOT previously attributed the active business of “Canadian Controlled Private Corporations” to the individual “United States shareholder”.
4. The Tax Cuts and Jobs Act has added a new Sec 965 to the Internal Revenue Code that purports to retroactively impose U.S. taxation on this (previously untaxed) active business income RETROACTIVELY FROM 1986. Yes, you read correctly.
I made the following comment to an article in the Financial Times which I believe fairly summarizes what this “tax” means in the lives of the “tax residents” of other countries (who are subject to U.S. taxation”:

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!

Further commentary on this article is here.
Dr. Karen Alpert offered the following insightful comment to an article in Canada’s Financial Post:

It is patently clear that Congress was not thinking about the impact of tax reform on non-resident US citizens. None of the discussion in the lead-up to tax reform, or in the committee hearings, indicated that Congress intended to punish the citizens and residents of other countries who happen to be claimed by the US as citizens. Nothing written by the IRS so far has indicated that they believe this applies to non-resident individuals – every example in the IRS notices has specifically looked at corporate shareholders. The only indication that this might apply to non-resident individual shareholders is from the tax compliance industry that stands to earn a large amount of fees on attempts to comply with this extra-territorial over-reach by the US.
If applied to non-resident individuals, the “transition” tax would be a pre-emptive grab at the tax base of Canada and every other country where US emigrants and Accidental Americans are living. The “deferred foreign income” that would be confiscated is money that was never subject to US tax, and is only claimed by the US because of a fictional “deemed repatriation”. Think about what that really means – the US is pretending that US emigrants are “repatriating” funds back to a country where they don’t live, and that they may no longer really identify with. The only good that could possibly come from this is the long overdue realisation that US taxation of the citizens and residents of other countries is contrary to the national interests of those countries and contrary to normal international practice.

(I encourage to read this insightful summary by Patricia Moon which appeared at the Isaac Brock Society.)
Should this “tax” apply to the “tax residents” of other nations, this would be an extraordinary escalation of the U.S. imposing “worldwide taxation” on the residents of other countries. The stakes are indeed high for individuals and for their countries of residence. After all, the application of this “tax” would be certainly a preemptive strike against the “tax base” of other countries! After all, this “tax” is not based ANY “realization event” whatsoever.
Understanding the problem in a 7 Part Video Series – Dr. Karen Alpert and John Richardson
(A description of each video is found along with the individual video. I suggest that you watch the videos in order.)
https://www.youtube.com/playlist?list=PLHF3nvfM47b1dWAvmqcrkVgEQ50BYQ-jv
Dr. Karen Alpert – FixTheTaxTreaty.org
John Richardson – CitizenshipSolutions.ca