Category Archives: Subpart F

Treasury 26 CFR § 301.7701-2 – Business entity definitions discriminate against Canadian Controlled Private Corporations

Synopsis:

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!

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Introduction

The United States imposes a separate and more punitive tax system on US citizens living outside the United States than on US residents. There are numerous examples of this principle – a principle that is well understood (but not directly experienced) by tax preparers.

The US tax system operates through a combination of laws, Treasury Regulations, enforcement by the tax compliance community and IRS administration. There are many instances where the extraterritorial application of the US tax system results in absurdities, that are very damaging to those who try their best to comply with those laws.

Treasury regulations have an enormous impact on how the Internal Revenue Code applies to Americans abroad. In a previous paper coauthored with Dr. Alpert and Dr. Snyder, we described how Treasury could provide “A Simple Regulatory Fix For Citizenship Taxation“. Treasury regulations can be extremely helpful to Americans abroad or extremely damaging. It is therefore crucial that Treasury consider how its regulations would/could impact the lives of those Americans abroad attempting compliance with the US extraterritorial tax regime. In some cases it may be appropriate to have different regulations for resident Americans than for Americans abroad.

Treasury has demonstrated that it can be very helpful

Although this post will focus on difficulties, it’s important to note that Treasury has demonstrated that it can be very helpful to Americans abroad. It has interpreted the Internal Revenue Code in ways that have mitigated what could have been extreme damage. Here are two recent examples from the GILTI context where Treasury:

– interpreted the 962 Election to allow individuals to receive the 50% deduction in GILTI income inclusion that was allowed to corporations; and

– interpreted the Subpart F rules to mean that ALL income earned by a CFC should be entitled to the high tax exclusion

Clearly some of the news coming from Treasury has been good!

The power to regulate is the power to destroy

This post provides examples of how certain Treasury regulations contribute to the application of the United States extraterritorial tax regime. The examples are found in the following two categories of regulations:

Category A: Foreign Trusts – The Form 3520A Penalty Fundraiser – Regulations That Are Unclear Resulting In Penalties

Category B: Business Entities Designated as “per se” Corporations – Creating CFCs In Unreasonable Circumstances (Canadian Controlled Private Corporations) – Regulations That Are Clear But Over-inclusive

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To punish 100 #GILTI Corporations is to punish millions more individuals

Introduction: As Goes Tax Reform For US Multinationals, So Escalates The Harm To Individual Americans Abroad

The Problem: The proposed changes in International Tax (mostly in relation to corporations) will affect numerically more individuals than corporations. The effects on Americans abroad, who run small businesses outside the United States, will be absolutely devastating.

Two Solutions: Suggestions for how to protect individuals (including Americans abroad) would be to make changes to the Subpart F regime – GILTI, etc. There are at least two ways this change can be achieved:

1. To NOT apply Subpart F to INDIVIDUALS who are shareholders of CFCs.

2. If Subpart F is to apply to individual shareholders of CFCs, it should NOT apply to those individual Americans abroad who meet the residence requirements to use the S. 911 Foreign Earned Income Exclusion. (I.e. people who are almost certainly tax residents of other countries.)

March 25, 2021 – The Senate Finance Committee Held A Hearing Described As:

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Proposal by @JoeBiden to increase the GILTI tax has particularly vicious implications for #Americansabroad

Introduction

Taxation is what America is about and America is about taxation.

Perhaps it’s better to say that:

Politics is about taxation and taxation is about politics.

Once Upon A Time In America

The primary legislative achievement of President Trump’s first term was the 2017 TCJA. It’s important to note that the TCJA had it’s genesis in the work of Michigan Congressman Dave Camp and was the result of a long term project of reworking the US tax system. It is absolutely incorrect to suggest that the TCJA was developed by the Trump Administration. It should not be referred to as “Trump Tax Reform”. That said, because of the “politics” involved in enacting the TCJA, the Trump Administration and Republican Controlled Ways and Means Committee, did impact the legislation at the margins. (Rate of repatriation tax, etc.)

Like all tax legislation the TJCA had clear winners and clear losers.

The TCJA Winner(s)

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Seriously now, who’s GILTI? Senators Wyden and Brown attempt to reinforce the punishment of GILTI Americans abroad

Introduction and July 2021 update …

There is wide agreement that the United States needs to improve its infrastructure. This will require massive spending. All spending necessitates a discussion of taxation. Since March 25, 2021 the Senate Finance Committee, Ways and Means Committee and the Biden administration have been exploring ways to increase taxation to pay for this. A series of SEAT submissions to the Senate Finance Committee is available here.

The community of Americans abroad has also recognized that any major tax reform creates an opportunity for a consideration of the United States transitioning to residence-based taxation. Although everybody claims to want residence-based taxation, the devil is in the details. As I have previously explained the words “residence-based taxation” mean different things to different people. The shared objective (of residence based taxation) is that the United States would cease imposing taxation on the non-US source income received by Americans abroad. That said, there are two broad ways that goal can be achieved. One way completely severs Americans abroad from US tax jurisdiction. The other leaves Americans abroad subject to US tax jurisdiction (forcing them to live in fear of every legislative change).

1. Pure residence-based taxation: Ending US tax jurisdiction over individuals who do NOT live in the United States. This would mean that Americans abroad would simply NOT be part of the US tax base. This is what residence-based taxation means in every other country of the world. In other words: you are not subject to US worldwide taxation because you don’t live in the United States. This is what I call “pure residence based taxation”. It is the only form of residence-based taxation that will solve the problems of Americans abroad. (This is what is advocated by SEAT.)

2. Citizenship-based taxation with a carve out: Continuing US tax jurisdiction over individuals who do NOT live in the United States, but relaxing the requirements that would apply to them. This proposal is what I call citizenship-based taxation with a carve out for certain people. Under this proposal, ALL Americans abroad would continue to be subject to US tax jurisdiction, but their non-US source income would (presumably) not be taxed by the United States. (This citizenship-based taxation with a carve out was the basis of the 2018 Holding bill and appears to what is being proposed by various groups. Further discussion of the Holding bill is here. It is essential that whenever a group announces that it is working toward residence based taxation that you ask them to clarify what they mean. Under the proposal, will Americans abroad remain subject to US tax jurisdiction? Will they still be defined as tax residents of the United States?)

(A more complete discussion about the difference between pure residence taxation and citizenship taxation with a carve out is here. A proposal for changes in the Internal Revenue Code that would result in pure residence-based taxation is here.)

Why completely ending US tax jurisdiction over Americans abroad (moving to pure residency-based taxation) is essential!!

The US tax code is incredibly complicated. The existence of citizenship-based taxation means that many changes in the tax code can impact Americans abroad even when the legislators are not considering the impact on Americans abroad. Since March of 2021 the Senate Finance Committee has been conducing hearings discussing tax reform for US corporations. The truth is that these proposals will affect many more individuals than corporations. Yet, Senate Finance never discusses the impact on individuals generally and individual Americans abroad in particular.

It is impossible for Americans abroad to survive when any change in the tax code could impact them without the legislators remembering that they even exist.

Let’s be clear! When it comes to Americans abroad:

It’s not that Congress doesn’t care about them. It’s that they don’t care that they don’t care!

This is why it is essential that ALL Americans abroad support and only support a movement toward “pure residence based taxation” which will ensure that nonresidents are NOT part of the US tax base.

If Americans abroad are left subject to the US tax based (citizenship-based taxation with a carve out) they will always be subject to being affected by any and all changes in US tax law.

A particularly egregious example of this in the following post. What follows is long, comprehensive and technical. Most will NOT want to read it.

But, the following post (written in 2020) is proof that ONLY pure residence-based taxation will solve the problems of Americans Abroad!

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Prologue

Americans abroad who are individual shareholders of small business corporations in their country of residence have been very negatively impacted by the Section 951A GILTI and Section 965 TCJA amendments. In June of 2019, by regulation, Treasury interpreted the 951A GILTI rules to NOT apply to active business income when the effective foreign corporate tax rate was at a rate of 18.9% or higher. Treasury’s interpretation was reasonable, consistent with the history of Subpart F and consistent with the purpose of the GILTI rules.

Now, Senators Wyden and Brown are attempting to reverse Treasury’s regulation through legislation. This is a direct attack on Americans abroad. Senators Wyden and Brown are living proof of the principle that:

When it comes to Americans abroad:

It’s not that Congress doesn’t care. It’s that they don’t care that they don’t care!

Introduction

As many readers will know the 2017 US Tax Reform, referred to as the Tax Cuts and Jobs Act (TCJA), contained provisions which have made it difficult for Americans abroad to run small businesses outside the United States. In the common law world a corporation is treated as a separate legal entity for tax purposes. In other words the corporation and the shareholders are separate for tax purposes, file separate tax returns and pay tax on different streams of income. The 2017 TCJA contained two provisions that basically ended the separation of the company and the individual for U.S. tax purposes. In other words: there is now a presumption (at least how the Internal Revenue Code applies to small business owners) that active business income earned by the corporation will be deemed to have been earned by the individual “U.S. Shareholders”. To put it another way: individual shareholders are now presumptively taxed on income earned by the corporation, whether the income is paid out to the shareholders or not! The effect of this on individual Americans abroad has been discussed by Dr. Karen Alpert in her article: “Callous Neglect: The impact of United States tax reform on nonresident citizens“.

The expansion of the Subpart F Regime

The Subpart F rules were established in 1962. The principle behind them was that individual Americans should be prevented from, using foreign corporations to earn passive income, in jurisdictions with low tax regimes (or tax regimes that have lower taxes than those imposed by the United States). The Subpart F rules have (since 1986) included a provision to the effect that investment income (earned inside a foreign corporation) which was subject to foreign taxation at a rate of 90% or more of the U.S. corporate rate, would NOT be subject to taxation in the hands of the individual shareholder.

To put it another way (with respect to investment income):

1. It was mostly investment/passive income that was subject to inclusion in the incomes of individual shareholders as Subpart F income; and

2. Passive income that was subject to foreign taxation at a rate of 90% or more of the U.S. corporate tax rate (now 21%) would NOT be considered to be Subpart F income (and therefore not subject to inclusion in the hands of individual shareholders).

To coordinate my background discussion with the Arnold Porter submission described below, I will refer to exclusion of investment income subject to a 90% tax rate as “HTKO” (High Tax Kick Out).

The basic principle was (and continues to be):

If passive income earned in a foreign corporation is taxed at a rate of 90% or more of the U.S. corporate tax rate, that there was no attribution of that corporate income to the individual U.S. shareholder.

In its most simple terms, the Subpart F rules are found in Sections 951 – 965 of the Internal Revenue Code. They are designed to attribute income earned by the corporation directly to the U.S. shareholder, without regard to whether the corporate profits were paid to the shareholders as a dividend. Note that many developed countries have similar rules. Many developing (from a tax perspective) countries (for example Russia) are adopting Subpart F type rules. The U.S. rules are more complicated, more robust and (because of citizenship taxation) apply to the locally owned companies of individuals, who do not live in the United States.

Punishing them for their past and destroying their futures – The expansion of the Subpart F Regime to active business income

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Part 34 – 2019: Treasury Fails To Prevent @MonteSilver1 lawsuit against @USTransitionTax From Proceeding – Case To Be Heard On The Merits

What Happened

The judgment is here.

We win!!!!!

About The Transition Tax

As part of the 2017 TCJA, Congress imposed a retroactive tax, without any realization event, on the retained earnings of Controlled Foreign Corporations. Although intended to be the the “trade off” for lowering the Corporate Tax rate from 35% to 21%, it was interpreted to apply to the small business corporations owned by Americans abroad. (The tax compliance industry aggressively promoted this damaging interpretation of the law.) In any event, this imposed significant and life altering consequences on Americans abroad (particularly in Canada) for whom their small business corporations were really their pension plans. I documented the history, damage and madness of this in a series of posts about the transition tax. The law was interpreted (in various ways) and the regulations were drafted in an extremely punitive manner. What needs to be most understood is that a law intended for the Apples, Googles, etc. was interpreted to apply in the same way to individuals (your friends and neighbors) who owned small business corporations.

About The Regulatory Flexibility Act

Title 5 of the U.S. Code of Laws deals with how the U.S. Government works. Subtitle 5 is the Administrative Procedure Act. Subtitle 6 is the Regulatory Flexibility Act. At the risk of over-generalization, the purposes of the Regulatory Flexibility Act are to require the Government to consider the effect that certain rules/regulations have on small businesses and undertake specific procedural steps in relation to this consideration.

Learn About the Regulatory Flexibility Act

An excellent site providing education about the Regulatory Flexibility Act is here. Although written in the context of the EPA, the description offers the following introduction to the Regulatory Flexibility Act:

The Regulatory Flexibility Act (RFA), 5 U.S.C. §§ 601 et seq, was signed into law on September 19, 1980. The RFA imposes both analytical and procedural requirements on EPA and on other federal agencies. The analytical requirements call for EPA to carefully consider the economic impacts rules will have on small entities. The procedural requirements are intended to ensure that small entities have a voice when EPA makes policy determinations in shaping its rules. These analytical and procedural requirements do not require EPA to reach any particular result regarding small entities.

The key is that Government is required by law to consider the economic effect of regulations on small business entities.

And here …

Monte Silver’s Lawsuit Against the Transition Tax – Treasury Did NOT Consider The Impact Of The Transition Tax Regulations on Small Business Entities (including those run by Americans Abroad

The lawsuit was not (like other lawsuits) against the Transition Tax per se. Rather the lawsuit was about the the failure of U.S. Treasury to comply with the procedural requirements of the Regulatory Flexibility Act. Predictably, the Government argued that the lawsuit lacked standing. On December 24, 2019 a U.S. District Court Judge ruled that the plaintiff (Mr. Silver) did have standing. The reason was that his lawsuit was not against the transition tax itself. Rather the lawsuit was against U.S. Treasury causing injury resulting from the failure of Treasury to comply with the requirements mandated in the Regulatory Flexibility Act.

Congratulation to Monte Silver for an incredibly important win. The success of his lawsuit opens the door to many similar lawsuits (GILTI anyone?) down the road.

Earlier posts

In November of 2018 I first wrote about Mr. Silver’s lawsuit.

That post included the following earlier interviews.

Speaking with Monte Silver …

Interview 1 – October 16, 2018

Interview 2 – November 15, 2018

John Richardson – Follow me on Twitter @Expatriationlaw

Part 33 – US residents bring suit alleging that the Section 965 US Transition Tax is Unconstitutional

A lawsuit alleging that the Section 965 transition tax is unconstitutional affords the opportunity to write Part 33 in my series of posts about the U.S. Transition Tax.

Part 22 of this series included a discussion of a paper by Sean P. McElroy which argued that the Section 965 repatriation tax was unconstitutional for the following reasons explained in the abstract:

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US Treasury proposes that foreign income subject to high foreign tax be excluded from definition of #GILTI

In general – Good News For American Entrepreneurs Abroad …

On Friday June 14, 2019 US Treasury proposed in Notice 2019-12436 that any foreign income earned by Controlled Foreign Corporations be (subject to election) excluded from the definition of GILTI income. This will be particularly welcome to Americans living outside the United States, who are attempting to carry on business in their country of residence, through non-U.S. corporations.

For those who are concerned with understanding the hows and whys, I suggest you read Treasury’s Notice which includes a good history and description of the Subpart F rules, some Legislative History leading to the GILTI rules, and Treasury’s attempt to piece it all together. You will find it all here.

Treasury Notice 2019-12436
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Part 32 – So, you have received a letter saying that your @USTransitiontax is also subject to the 3.8% NIIT


This is Part 32 of my series of blog posts about the Sec. 965 transition tax. I recently received a message from a person who says that he was assessed a Section 1411 Net Investment Income Tax assessment on the amount of the Section 965 transition tax. Although not intended as legal advice, I would like to share my thoughts on this. I don’t see how the transition tax could be subject to the NIIT.
Let’s look at it this way:
Why Section 965 Transition Tax Inclusions Are NOT Subject To The Sec. 1411 Net Investment Income Tax
A – The Language Of The Internal Revenue Code – NIIT Is Not Payable On Transition Tax Inclusions

I see no way that the language of the Internal Revenue Code leads to the conclusion that the transition tax can be subject to the NIIT.
My reasoning is based on the following two simple points:
1. The NIIT is based on Net Investment Income which is generally defined as dividends, interest and capital gains as per this tweet:


2. Subpart F income by legal definition (controlling case law) is NOT interest, dividends or capital gains as per this tweet


B – The Purpose Of The Section 965 Transition Tax
3. The whole point of the transition tax is to go after active income that was not subject to U.S. tax when it was earned. There is nothing about the transition tax that converts active income into investment income by making it a subpart F inclusion as per this tweet:


Therefore, (and this is speculation on my part) the NIIT charge must be based on something specific to your tax filing – likely treating the transition tax inclusion as meeting the definition of Net Investment Income – specifically Dividends, Interest or Capital Gains.
Under no circumstances should you or anybody else impacted by this simply pay a NIIT surcharge on the transition tax, without a careful and meticulous investigation of the reasons for it. Have a good look at your tax return.
The mandatory disclaimer: Obviously this is not intended to be legal advice or any other kind of advice. It is simply intended to give you the framework to discuss this issue with your tax preparer if you were one of the unfortunate victims who received an NIIT tax assessment on your acknowledged transition tax liability.
John Richardson – Follow me on Twitter @Expatriationlaw

Part 31 – "Double Taxation Disguised as Tax Reform": Jackie Bugnion comments in @TaxNotes on @USTransitionTax and #GILTI

https://twitter.com/worldnewsreader/status/1132961693598986241

This is Part 31 of my series of blog posts about the Sec. 965 transition tax. It is a “guest post” by Jackie Bugnion who is the former tax direction of ACA. The article explores the impacts of the Section 965 transition tax and GILTI on the lives of Americans abroad. Ms. Bugnion places the transition tax and GILTI in the context of the U.S. system of citizenship-based taxation.

This article is reproduced with thanks to the author Jackie Bugnion and the publisher Tax Analysts.

Bugnion (4-29)

Bugnion (4-29)

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