Category Archives: Subpart F income

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

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

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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:
summary_of_chairman_amendment_2
Now back to our regular programming …
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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.
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The worldwide trend of attacking the use of corporations as a way to reduce or defer taxation for individuals

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Introduction – The war against corporations and the shareholders of those corporations
Corporations as entities that are separate from their shareholder/owners
As every law students knows, a corporation is a legal entity that is separate from its owner. As a legal entity that is separate from its owner, a corporation is capable of holding assets, carrying on a business and investing in a way that results in separation of the shareholder(s) from the business itself. It is a mistake to infer that the corporation’s status as a separate legal entity means that the corporation’s income will not be taxed to its shareholders.
Corporations as legal instruments of tax deferral
When corporate tax rates are lower than individual tax rates, there is incentive for individuals to earn and invest through corporations rather than to earn and invest as individuals. In other words, in certain circumstances, corporations can be used to pay less taxes.
Corporations as instruments of tax evasion
In many jurisdictions is it possible to create a Corporation and NOT disclose the identities of the beneficial owners. Because of this circumstance:
1. Corporations (as was made clear in the “Panama Papers Story”) can be used to hide income and assets for either legitimate or illegitimate reasons; and
2. Corporations can be used to avoid the attribution of income earned by the corporation to the shareholders.
Corporations and the rise of @TaxHavenUSA
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Form 8621 and Form 5471 are required even if the tax return is NOT!

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The Internal Revenue Code of the United States requires two things:
1. The calculation of taxes; and
2. The reporting of information.
The Internal Revenue Code of the United States is based on three basic principles:
1. A dislike of all things “foreign”. (If you see the word “foreign” a penalty is sure to follow.)
2. A hatred of all forms of non-U.S. “tax deferral”
3. An attempt to stop the “leakage” of “U.S. taxable assets” from the U.S. tax base. (Examples include the U.S. tax treatment of the “alien spouse” and the U.S. S. 877A “Exit Tax” that may be payable when one makes the decision to renounce U.S. citizenship).
“Forms” AKA “information returns” are for the purpose of forcing disclosure of information relevant to  “foreignness”, “deferral” and “leakage”.


The above tweet references an earlier post describing many of the “forms” required of Americans abroad. The post also describes the significant penalties which can be potentially imposed for the failure to file those forms.
For Americans abroad the information reporting requirements are extensive, burdensome and penalty laden. Normally (but not in all cases) the “forms” are filed as part of the tax return (1040 or 1040NR).
NEVER FORGET MR. FBAR – THE NEW SYMBOL OF U.S. CITIZENSHIP – AND THE POTENTIAL FBAR PENALTIES FOR FAILURE TO FILE THE FBAR! THOSE WHO HAVE FAILED TO FILE MR. FBAR SHOULD BE CAUTIOUS ABOUT HOW THEY “FIX THE FBAR PROBLEM“.
(Interestingly, Mr. FBAR has been used as a model for Russia which now has (for lack of a better term) the Russian FBAR.)
Many people do NOT understand that they may be required to file “information returns”, even though they may NOT meet the income thresholds to file a tax return!
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