Cross-posted from the citizenshipsolutions blog
Part 1: Responding to The Section 965 “transition tax”: “Resistance is futile” but “Compliance is impossible” https://t.co/HMUi0Nw1rU
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) March 2, 2018
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.
Leaving aside the theory, the reality is that for many Canadian residents, the application of this Section 965 “transition tax” would operate to effectively “confiscate” their pension plans. “Confiscation” is what is really happening. But, “tax professionals” refer to this process of “confiscation” as a “Subpart F” inclusion.
An simple example of a “Subpart F” inclusion (assuming that the U.S. Section 965 “transition tax” applies to Canadian residents) …
John Smith lives in Canada and is a Canadian citizen. He was born in Canada to a U.S. citizen father. He is therefore considered to be a U.S. citizen living in Canada. John Smith also has a small business and over a 30 year period has managed to accumulate 1 million dollars of undistributed income in his corporation. He dutifully files his U.S. tax returns every year. Understand that this 1 million dollars of retained earnings was never subject to U.S. tax. On December 22, 2017 President Trump signed the TCJA which (according to a majority of “tax professionals”) retroactively subjects that 1 million dollars to a one time U.S. tax. So, John would be required to include 1 million on his U.S. tax return for a one time confiscation tax. Note that there is no “taxable event” in Canada. So, in theory, John Smith would be required with respect to the 1 million dollars to FIRST pay tax on it in the United States and SECOND pay tax on it Canada. In other words, (assuming the applicability of the tax) it would amount to:
1. A U.S. tax on the undistributed earnings of a Canadian Corporation (Say what??) (this is accomplished through the “back door” by imposing the tax on the shareholder and not the corporation); and
2. Very likely “double taxation”. The sequence of events leading to the “double taxation” are:
Re: The question of double taxation
As a reminder, we are discussing the “transition tax” applied to individual shareholders who are “tax residents” of other countries and subject to taxation in those countries.
Here is the order of events as contemplated by the Internal Rev. Code 965:
1. Inclusion of retained earnings in income of U.S. shareholder and U.S. tax paid on that deemed distribution.
2. The 965 deemed distribution is taxable in the U.S. but there is no taxable event in the country of residence and therefore no tax paid in the country of “tax residence”.
3. There is no credit allowed for the U.S. tax paid (in the year the transition inclusion is made) on the individual’s tax return where he actually lives.
4. When the amount that was the 965 distribution is later distributed in the country of tax residence the individual is taxed on that amount a second time.
The amount 965 inclusion is taxed twice (first by the United States and then by the country of residence).
Bottom line: Both Canada and the United States have a very keen interest in the “retained earnings of Canadian Controlled Private Corporations”. It’s too bad that you have one.
The response of the “tax compliance industry” …
Karen Alpert (of “Fix The Tax Treaty“fame) in a comment to recent post about the Transition Tax, published at “Tax Connections” writes:
It is frustrating that much of the tax compliance industry seems to be just rolling over on both the transition tax and GILTI. They are writing articles that tell US expats that they must just comply, even when compliance will have a serious adverse effect on planned retirement savings and the financial viability of businesses owned by US expats.
Where are the tax professionals who are working on ways to get around a literal interpretation of the legislative language? Is Congressional intent irrelevant? Are there treaty positions that could be taken, or appeals that could be made to the Competent Authorities under the tax treaties that these TCJA provisions are contrary to the intent of the treaty? Are there other avenues to challenge this law in the courts? Is anyone pursuing change or clarification from Congress (or the IRS)?
Resistance is futile!
Think of it! The tax compliance industry is largely telling people that the Section 965 “transition tax” applies to them and they must surrender a good part of (what is for many) their pensions to the IRS. An interesting discussion of the “Resistance if futile” principle is found in the Facebook discussion in the following tweet:
Taxes, the @USTransitionTax, the news and #FakeNews – What is fake, what is real? Do the taxpayers or does the tax compliance industry get to decide which is which? Great Facebook discussion going on … https://t.co/j5txASpFdi
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) March 1, 2018
Some “tax professionals” are behaving as though the United States is an “occupying power”, the “tax professionals” are the representatives of the United States and their role is to impose the “transition tax” on a conquered people (The “It’s U.S. law” principle.)
Compliance is impossible!
While the tax compliance industry continues the “Resistance is futile” drumbeat, Canadians with undistributed earnings in CCPCs are dealing with the reality that “compliance is impossible”. The reasons for the impossibility are both “contextual” and “logistical”. Both set of reasons are discussed in the 7 part video series about the Internal Revenue Code Sec. 965 “Transition Tax” created by John Richardson and Dr. Karen Alpert.
Understanding the @USTransitionTax – the possible implications for small for small business owners who do NOT reside in the United States – A 7 part video series with John Richardson and Dr. Karen Alpert https://t.co/MfsK7ArrcL
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) February 13, 2018
(Video 6 gives examples of what various approaches to “Transition Tax Compliance” might look like.)
Contextual reasons that compliance is impossible …
– “Tax professionals” are just as confused about how to impose the tax on Canadian individuals, as individuals are about what is expected of them
– some modes of compliance (for example the Sec. 962 election will require records that may no longer exist
– few (if any) have financial statements that have been done according to U.S. accounting principles
– the rules are even less understood for those corporations do not have a December 31, year end
– there is a lack of agreement on what percentage of certain Canadian taxes can be used as a tax credit, etc.
Logistical reasons that “compliance is impossible” …
– assuming the application of the “transition tax”, as Charles Bruce of “American Citizens Abroad” fame notes, people may not have the money to pay the tax. After all, this is a retroactive tax with no “realization event”
– in order to find the money to pay the “transition tax”, the corporation would have to sell assets. The effect of the sale would be to generate further taxes and so on and so on …
– in order to find the money to pay the transition tax one could: First, renounce U.S. citizenship (meaning that one would no longer be subject to U.S. tax jurisdiction) and then Second, sell his/her principal residence in Canada (which would then be a tax free capital gain) and use the proceeds of the sale to pay the tax!
Readers should understand that the operation of the “transition tax” is the confiscation of the assets (and for some is their pension).
The “tax compliance industry” teaches that, when it comes to the Section 965 “Transition Tax”:
“Resistance is futile” (according to most tax professionals) and “Compliance is impossible”.
http://www.citizenshipsolutions.ca/2018/03/02/part-1-responding-to-the-section-965-transition-tax-resistance-is-futile-but-compliance-is-impossible/
Rather than accepting that “Resistance is futile”, let’s consider how the Canada/U.S. Tax Treaty might impact this issue.
In closing please remember four basic points:
1. The U.S. Transition Tax is a U.S. tax on the “undistributed earnings” of a Canadian corporation; and
2. Absent deliberate and expensive mitigation provisions, the U.S. transition tax contemplates the “double taxation” of Canadian residents who hold U.S. citizenship.
3. The “transition tax” is a “tax strike” against a corporation in Canada. Historically Canada would have the first right of taxation over Canadian companies.
4. The U.S. Transition Tax creates a “fictitious” taxable event. It is not triggered by any action on the part of the shareholder.
This concludes Part 1. In Part 2 I will explore how the U.S. Canada tax treaty may provide some protection from the Section 965 transition tax.
“Compliance is impossible!”
Compliance is surely unnecessary.
@plaxy (and all contributors to posts on Brock)
The point of this post is not about whether to comply with the Transition Tax or not. It is to stimulate discussion, look for supporting or new ideas that will help us defeat this notion that small, individual shareholder-owned CFCs are liable for this tax. We need to convince the powers that be, not just those who read Brock or enjoy contributing to the discussions here. We need something more along the lines of the “old days” at Brock.
This post took an incredible amount of work and thought to write. It deserves the attention, thought and focus of those who take part here. To repeat the “you don’t have to comply” theme that permeates the site nowadays, is to diminish a valuable and necessary effort.
I am sure this was not your intention plaxy. But this time, we need your input and considerable intellect to weigh in, help the idea expand, etc. Please help,
It has been clear for quite some time that the US Congress really has no idea how the laws it passes affect Americans who live outside the US. The taxation of the residents of other countries just has to stop. If the US treated its nonresident citizens in the same way as all other developed countries, then we wouldn’t have the tax compliance industry trying to figure out how to fit square pegs (local business structures in other countries) into round holes (the rules in the Internal Revenue Code).
It is refreshing to see someone putting forth arguments that will actually help. The new “Transition Tax” as applied to nonresident US citizens is a grab at the tax base of other countries. This is what tax treaties are meant to fix; so invoking the treaty is a perfect response.
The argument that this is a tax on the undistributed profits of a foreign (Canadian) corporation is both novel and obvious at the same time. The legislation clearly states that it targets undistributed profits – and the US would have no way to tax the undistributed profits of a Canadian corporation outside of subpart F. But, if the treaty says that undistributed profits cannot be taxed, then subpart F is contrary to the treaty. The beauty of this position is that, by making the argument at the corporate level, the saving clause is completely bypassed.
The alternative argument that this represents double taxation at the shareholder level is further ammunition for our home governments (via the Competent Authority) to fight back against this extraterritorial application of US tax. As it is already too late to use a dividend strategy to avoid payment of the first instalment of the transition tax (it’s too late to declare a dividend which will generate 2017 Canadian tax to use as FTC), and as the section 962 election will not eliminate the transition tax unless the CFC’s effective foreign tax rate is above 35%, application of the transition tax will clearly result in tax being paid to the US on Canadian source income that will eventually be taxable in Canada. Just because the tax hasn’t yet been incurred, doesn’t mean that the taxpayer will not be forced to pay the tax at some point in the future. In fact, if we were valuing a business with unrealised gains/income, the “tax overhang” would reduce the value of the business.
“help us defeat this notion that small, individual shareholder-owned CFCs are liable for this tax.”
Couldn’t agree more. Ignore it. Why make a fuss about it?
If USCs with small corporations pay the tax and then try to contest it in US courts, they’re dead in the water. They’ll have basically helped to create an assumption that they’re liable to pay, they’ll have actually paid, and they won’t get their money back. The US administration can’t afford to lose a court case on its prize tax reform. They don’t care about Joe the Plumber’s savings but they do care about Apple’s. Once Joe pays, he becomes unmistakably liable to pay and can’t be allowed to keep his savings. Why is that a good outcome for Joe?
Equally, if USCs with small corporations try to use the MAP procedures to avoid paying on the grounds of double taxation, once again by assuming they’re liable to pay they’ll have helped to establish that they’re liable to pay, and the only question the Competent Authorities will be looking to answer is which weasel words to use when they rule that the USC must indeed pay. And indeed the USC must pay, once he’s asked the Competent Authorities to decide.
Assuming that Joe is somehow being forced to pay is playing the IRS’s game: make a law and wait for payment.
If you refuse to play the game, and don’t volunteer to send them a cheque, they’ll do nothing. There’s nothing they can do. If you get up petitions and write to every American Congressman (!!), deploring the terrible thing that is being done to USCs with small corporations even though nothing’s actually being done to USCs with small corporations, you just help to cement the presumption that USCs with small foreign corporations must pay, because what the heck do you expect them to say?
“We need to convince the powers that be,”
The powers don’t be. USCs who angst about this tax are giving them the power, by assuming that they have it.
@Karen I think you all need to get away from this thought that US congress has no idea about what expats are going through. After repeated letters to my congressman I received a letter from him that US has right to tax anyone anywhere and it is the law of the land. So renounce if you want to. They are fully aware and they want blank checks to write to IRS after taxing us and forcing us to comply through their condors who scare us in every ad about complying. While some of us can’t escape compliance those who can more power to them. I am glad Patricia put up two new threads today. Thanks Patricia.
Some of the congressmen/congresswomen may feel sympathy but are terrified of being brandished as helping tax evaders. They will never ever repeal CBT. Renounce and rejoice. Or stay low if you can
Although I’ve renounced, I’m still going to throw my hat in the ring here. I agree with Plaxy, Karen and Harrison. The US knows full well what it is doing and no relief should be expected. Indeed, it’s more likely to get worse. Playing into America’s hands by complying with the latest in unfair, unjust, unrelentless taxation schemes, designed to punish and confiscate, is illogical. If a US person needs to be compliant, then they should keep it to a minimum and not volunteer any information that the agency wouldn’t know otherwise; they should also not fall victim to whatever the tax code “deems” or “contructs”, e.g. the 5471 Information Return of U.S. Persons With Respect To Certain Foreign Corporations, where a USC is expected to report on their constructed shares in their NRA spouses corporation. Who in their right mind would submit to this invasion of a non-resident-alien’s privacy?! Nevermind the fact that collecting the information requested technically would bend, if not break, the laws of the corporation’s country. Like Karen says, the whole square peg/round hole blanket application of the tax code has got to end because compliance with two different tax systems is impossible. Renounce and rejoice (when possible) is the only solution.
@Petlover congratulations. My lawyer friend told me decade ago to renounce right away too bad I didn’t listen to his advice as he was correct that it is going to get worst and we now see all the impacts of it. First the fees were increased from 0 to 400 to 2350. Likely to increase soon. Two interviews required instead of one and now months or weeks apart of each other in different countries. US citizenship is a liability compliance or not. I realise and regret everyday about not renouncing decade ago when it was easier. US congress knows fully well your situation and is going to go on relentless actions against you by passing more laws and more actions. As my congressman’s letter told me if you don’t like our laws that cover the entire planet you can go ahead and renounce permanently. Divorce and be happy.
“As it is already too late to use a dividend strategy to avoid payment of the first instalment of the transition tax (it’s too late to declare a dividend which will generate 2017 Canadian tax to use as FTC)”
Form 1116 line 10 allows Canadian taxes accrued or paid in 2018 to be carried back to 2017. Enter a negative number in line 10 for 2018 and a positive number in line 10 for 2017.
There are at least two problems.
1. Which year was the income earned or received, so that the carryback corresponds to income on line 1a instead of falling into a black hole?
2. How do you compute the actual amount to be carried back? The IRS was never capable of giving correct instructions for this computation. If you call an estimate an estimate you get penalized in addition to being denied refunds of US withholding, so you have to declare under penalty that to the best of your knowledge and belief the numbers are true and correct regardless of whether you actually believe it. That is, honesty is illegal but perjury is legal, and that’s how things are in the US.
But anyway, this still serves the US’s purpose of preventing its US’s diaspora from saving for retirement. If a US citizen resides in Canada and is penniless in retirement then she/he gets welfare from Canadian taxpayers instead of from the US. Or if the US citizen resides in Japan or the Philippines and is penniless in retirement then he/she can starve to death. Win-win-win for the US.
“If you refuse to play the game, and don’t volunteer to send them a cheque, they’ll do nothing. There’s nothing they can do.”
Except if you don’t hold citizenship in the country you live in.
But yes, yet again, non-compliance breaks the law but compliance brings punishment.
The D.C.Pukes will stop at nothing when they view every expax as a Tax Dodging criminal who just hasn’t been caught.
How many times and in how many ways does the US government have to tell its expats:
“WE DON’T CARE ABOUT YOU. WE DON’T HAVE AND NEVER WILL HAVE THE SLIGHTEST CONCERN ABOUT THE RUINOUS EFFECT OUR LAWMAKING HAS ON YOU. WE WILL CONTINUE TO PERIODICALLY ENACT LEGISLATION SPECIFICALLY INTENDED TO PUNISH YOU FOR LEAVING THE HOMELAND.”
Those who know they will never return can safely ignore the transition tax with or without renouncing.
Those who think they might want to return to the Homeland someday have 2 choices;
1. They can accept financial destruction and pay the tax.
2. They can consider ways to minimize or entirely avoid the tax by means of selective reporting.
@maz57. And you will shoot yourself more in the foot by selective reporting. I read http://www.sovereignman.com today and they had an article just about this topic how to reclassify the single owned corporation which was previously a disregarded entity and reclassify as C-corp and to buy stocks, bonds, real estate with deferred tax, so you don’t have to pay any tax now. Read it over maybe it will help a few of you who are complying and rich enough. For those who aren’t more power to you.
@plaxy
The tax compliance industry is rampantly publishing articles etc telling people with CFCs they are liable for this tax. There is a rush to pay an estimate by April 15. (If you have not seen this/ don’t believe me do a search. There are only two people refuting the information with reasoned arguments. John and Karen. Now a third-party -an attorney in Israel.) That is why we are “making a fuss about it.” There needs to be information and action that presents the other side of the story. Brock started to inform people re FBAR, relinquishment, and so on. We were the ONLY voice doing that at the time. If we had not, I imagine an awful lot more people would have assumed what they were being told was true and they would have come into compliance. I don’t have to imagine that we somehow did the wrong thing and helped cement the idea that government and compliance industry were right. The results are obvious.
It is no different here. The tax compliance industry has decided their reading of the statute, without any regard for the context , is the law. There are real people coming forward who don’t want to to pay this but are assuming they have to and are indicating that they WILL pay it. Not a hypothetical account, REAL people. It won’t occur to them that they might resist if there aren’t other voices out there giving them the information they are not hearing elsewhere.
Unfortunately the “powers that be” are very real for some people. Of course some people will figure out not complying is ok. But I don’t see how that means the total response should be only that. If anyone listened to the Congressional hearings, I don’t see how one could walk away with the notion these guys intended this toward expats. It is clear they hardly understood it at all. The drafters of the statute, that’s where the I would agree, they understand what they are inflicting.
I have two complementary but contradictory views on the CFC issue:
1. Anyone who pays this tax is a bonehead.
2. People might pay this tax because the compliance industry won’t explain why point #1 is true.
Karen – “The legislation clearly states that it targets undistributed profits – and the US would have no way to tax the undistributed profits of a Canadian corporation outside of subpart F. But, if the treaty says that undistributed profits cannot be taxed, then subpart F is contrary to the treaty. The beauty of this position is that, by making the argument at the corporate level, the saving clause is completely bypassed.”
Unfortunately, it isn’t. A USC can’t “bypass” the treaty saving clause – the treaty simply doesn’t apply for USCs except for the very limited exceptions stated – which don’t include Article X.
Patricia – telling USCs the facts on FBAR and relinquishment etc is one thing, and very much to be commended. Suggesting that a USC foreign corporation owner take a treaty position claiming treaty exemption from the transition tax, is a very different kettle of fish indeed. The USC has no entitlement to treaty benefits, apart from those excepted from the saving clause.
Ignoring the transition tax altogether would be much much safer. Trying to get the IRS to give you (generic you) permission not to pay it is asking for trouble – and the IRS will be right there ready to deliver your order.
I noticed the tax attorney in Israel (Monte Silver?) who was objecting strongly to the transition tax. Ideal person to contest it, I would say: he has no choice but to be compliant so he has little to lose from arguing about it. If he wins, excellent. If he loses, he can afford to pay while normal USC owners of foreign corporations can just continue ignoring the tax.
Plaxy,
It’s the corporation that has undistributed profits, and the corporation is not a US person or subject to the saving clause. The argument here is that the transition tax is a back door tax on the corporation itself, and that the treaty says the US has no right to tax the corporation.
From the so-called “Technical Explanation” of the treaty.
https://www.irs.gov/pub/irs-trty/canatech.pdf
My view – not worth trying to beat them at their game. The dice are loaded.
#NotPayingThis
@plaxy
This still reads like an accusation. It is an option a person who tends toward compliance may find helpful. And you cannot predict that it will not work. I understand that it is a very difficult fight. But you and I are not in the position these people are in. They are compliant. They have filed 5471s. A lot of these people are accountants and lawyers. They are not inclined toward non-compliance. What matters is whether they find it helpful or not.
I don’t know anything about Monte Silver nor would I make the assumption that he can afford to pay. Just because he is a lawyer does not mean on its face alone, that he is wealthy. It depends upon how old he is, how long has he been abroad, how much does he actually have in his retained earnings, does he plan to remain in Israel and on and on. I see some members of the tax compliance community implying that they are in the same boat but is it really the same boat? It depends upon so many factors.
I agree wholly with Karen and John. A corporation is a type of taxpayer and is not an individual.
One fights back.
“you cannot predict that it will not work. ”
Oh yes I can.
However, as you say, it’s up to the USC owners of foreign corporations to decide what to do in their own particular case..
Canadian residents who are owners of these things need to acquire Canadian citizenship ASAP if they haven’t already. Who knows how long it will actually take for the IRS to get around to determining that USCs who are otherwise compliant owe this new tax?
If they can become Canadians in the meanwhile then they will then at least have the CRA’s “We won’t collect from Canadian citizens on behalf of the IRS if, when the tax debt was incurred, the taxpayer was a Canadian citizen” on their side.
Yes, good point.
@Harrison
“And you will shoot yourself more in the foot by selective reporting. I read http://www.sovereignman.com today and they had an article just about this topic how to reclassify the single owned corporation which was previously a disregarded entity and reclassify as C-corp and to buy stocks, bonds, real estate with deferred tax, so you don’t have to pay any tax now.”
By selective reporting I didn’t mean trying to figure out some sort of fancy footwork to do an end run around the rules. They make the rules so its not likely one could beat them at their own game.
What I had in mind was more along the lines of “Never tell the IRS anything they don’t already know”.