US tax reform bill appears to confiscate 12% (updated to 14%) of retained earnings of certain Canadian Controlled Private Corporations

Update November 9, 2017
Today Chairman Brady concluded the “Mark Up” period of his proposed tax legislation. The “Mark Up” period contained NO move to “territorial taxation” for individuals. It did increase increase the “proposed confiscation” of the retained earnings of certain Canadian Controlled Private Corporation, from 12% to 14%.

See the “Manager’s Amendment” here:
Now back to our regular programming …

Kudos to Max Reed for his quick analysis of the how the proposed U.S. tax reform bill might affect Canadians citizen/residents who also have hold U.S. citizenship. You will find the bill here. His analysis, which has been widely discussed at the Isaac Brock Society (beginning here) includes provisions that are very damaging to those who are the owners of Canadian Controlled Private Corporations (noting they are also under assault from Messrs Trudeau and Morneau). The damaging provisions are both prospective and retrospective.

First the prospective as described by Max …

New punitive rules that apply to US citizens who own a business. Currently, most US citizens who own a Canadian corporation that is an active business don’t pay tax on the company’s profits until they take the money out. The House plan changes this. It imposes a new, very complicated, set of rules on US citizens that own the majority of a foreign corporation. The proposal would tax the US citizen owner personally on 50% of the entire income of the Canadian corporation that is above the amount set by an extremely complex formula. At best, this will make the compliance requirements for US citizens that own a business extremely complicated and expensive. At worst, this will cause double tax exposure for US citizens who own a Canadian business on 50% of the profits of that business.

Second the retrospective as described by Max …

Imposition of a 12% one-time tax on deferred profits. Under the new rules, the US corporate tax system is transitioning to a territorial model. As part of this transition, the new rules impose a one-time 12% tax on income that was deferred in a foreign corporation. Although perhaps unintentional, since US citizens will not benefit from a territorial model, the new rules impose a 12% tax on any cash that has been deferred since 1986. Take a simple example to illustrate the enormity of the problem. A US citizen doctor moved to Canada in 1987. She has been deferring income from personal tax in her medical corporation and investing it. Now, 12% of the total deferred income since 1986 would be subject to a one-time tax in the US. That may be a significant US tax bill.

About the retrospective: In other words, the U.S. as part of a transition to “territorial taxation” for U.S. corporations is proposing to confiscate 12% of the retained earnings of Canadian Controlled Private Corporations that are owned by Canadians who hold U.S. citizenship. At first, I had found difficult to believe that this could be true. It’s bad enough to do this to U.S. residents. But, the U.S. tax bill if read literally, is broad enough to extend to Canadian Controlled Private Corporations. Could this really be happening? Would the U.S. effectively “Cyprus” the retained earnings of CANADIAN Controlled Private Corporations? Although hard to believe, it’s worth noting that the main effect of the U.S. S. 877A Exit Tax is to confiscate non-U.S. assets (including Canadian pensions) which were accumulated after a person moves away from the United States. It’s also true that the Obamacare surtax applies to distributions from Canadian RRSPs but does not apply to distributions from IRAs. But, I digress …
In any event, a summary of the new tax bill has been released and is available for your reading pleasure here.
The summary starting on page 253 includes:

4. Treatment of deferred foreign income upon transition to participation exemption system of taxation
Description of Proposal
In general
The proposal generally requires that, for the last taxable year beginning before January 1, 2018, all U.S. shareholders of any CFC or other foreign corporation that is at least 10-percent U.S.-owned but not controlled (other than a PFIC) must include in income their pro rata share of the accumulated post-1986 deferred foreign income and which was not previously taxed. A portion of that pro rata share of deferred foreign income is deductible; the amount deductible varies depending upon whether the deferred foreign income is held in the form of liquid or illiquid assets. The deduction results in a reduced rate of tax
applicable to the included deferred foreign income. A corresponding portion of the credit for foreign taxes is disallowed, thus limiting the credit to the taxable portion of the included income. The increased tax liability generally may be paid over an eight-year period.
Subpart F inclusion of deferred foreign income
The mechanism for the mandatory inclusion of pre-effective date foreign earnings is subpart F. The proposal provides that the subpart F income of all specified foreign corporations is increased for the last taxable year that begins before January 1, 2018, by its accumulated post-1986 deferred foreign income. In contrast to the participation exemption deduction available only to domestic corporations that are U.S. shareholders under subpart F, the transition rule applies to all U.S.
shareholders of a specified foreign corporation. A specified foreign corporation means (1) a CFC or (2) any foreign corporation in which a domestic corporation is a U.S. shareholder (determined without regard to the special attribution rules of section 958(b)(4)), other than a PFIC that is not a CFC.

Those who are interested in more detail are invited to read the complete information.
My thoughts …
When one reads this, it seems clear that the lawmakers are visualizing U.S. residents who are individual shareholders of CFCs or other foreign corporations. They seem to be completely oblivious to the fact that this provision – taken literally – would apply to citizen/residents of other countries who have corporations in those countries. These corporations are obviously not foreign to those individual shareholders.
This is probably one more unintended consequence of citizenship-based taxation. That said, it is taking citizenship-based taxation to an new and heightened level of obscenity that has never before been contemplated. In short, the United States of America is seriously proposing to confiscate the retained earnings of Canadian Controlled Private corporations which are owned by Canadian citizen/residents.
The time has come for the Government to take a principled stand against this absolutely “over the top” intrusion into Canada. The United States is in fact turning all U.S. citizens residing in other countries into instruments of confiscation.
Under no circumstances can this be tolerated. Those who are concerned about this should write your MP and contact Finance Minister Morneau. It seems clear that the United States is looking to increase it’s tax base beyond its borders. FATCA and the FATCA IGAs play a major role in helping the United States identify “U.S. citizens”. The IGAs also help identify those “entities” (including corporations) that are owned by Canadians who also hold U.S. citizenship.
It is increasingly clear that survival as a U.S. citizen outside the United States is impossible. I expect that this provision will encourage even more renunciations. Even if the provision is corrected, it demonstrates that the United States has no regard whatsoever for it’s citizens abroad or for the sovereignty of other countries.
In closing …

Gotta love it!!
The “centerpiece” of the tax reform bill is a move away from the taxation of “worldwide income” earned by U.S corporations, to “territorial taxation” for those corporations.
For most countries a move to “territorial taxation” means that the country taxes ONLY income earned in its “territory” (in this case the USA).
When the USA moves to “territorial taxation” it means that it now claims the right to impose taxation on more income earned OUTSIDE it’s territory in Canada!
This shows you the perverse effects of U.S. “taxation-based citizenship”.
Seriously, “you can’t make this up!”

John Richardson

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