cross posted from citizenshipsolutions
by John Richardson
Brilliant! @FinMusings explains how @USTransitionTax allows USA to collect tax on income that never would have resulted in U.S. tax payable! By changing timing and "frontrunning" USA creates a "fictional event" to tax CDN income before Canada can tax it! https://t.co/hnDu6x7y5K
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) April 4, 2018
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.
The first six posts in my “transition tax” series were:
Part 3: Responding to the Sec. 965 “transition tax”: They hate you for (and want) your pensions!
Part 6: Responding to the Sec. 965 “transition tax”: A “reprieve” until June 15, 2018
This post will draw on the lessons/discussion from the first six posts. Yesterday Karen Alpert and I participated in an interview about the “transition tax” which was organized by “TaxLinked“. We discussed the impact of the “transition” tax from both the “microeconomic” (how it impacts individuals) and “macroeconomic” (how it impacts countries) perspective.
Microeconomic Perspective:
In Part 4 of this series of posts I specifically compared the impact of the Sec. 965 “transition tax” on “Homeland Americans” to the impact on “Residents of other countries“. I explained how the Section 965 “transition tax” was a good (or at least not bad) thing for Homeland Americans, but was a disaster for the residents of other countries. This was a “microeconomic” discussion of the effects of the “transition tax”. Another good “microeconomic” discussion of the Sec. 965 “transition tax” is on Virginia La Torre Jeker’s blog here.
Macroeconomic Perspective:
The purpose of this post is to discuss the effects of the Sec. 965 “transition tax” on other countries, from a macroeconomic perspective. In other words:
“In what respect or respects does the “transition tax” directly impact the economies of Canada and other countries?
The answer is as follows:
The Section 965 “transition tax” creates a “fictitious tax event” that allows the United States to enter another country and impose taxation on a pool of capital:
1. That the other country has primary taxing jurisdiction over; and
2. Before the other country exercises that “taxing jurisdiction”.
Here is the sequence of events that explains how this happens:
1. An individual living in Canada creates a Canadian Controlled Private Corporation.
2. That private corporation earns profits. Some of the profits are paid out as dividends or salaries to the shareholder. In many cases that Canadian Controlled Private Corporation operates as a “private pension plan”. What is not paid out remains in the company as “undistributed earnings”.
3. Canada will NOT impose taxation on those “undistributed earnings” until those earnings are actually distributed.
4. The United States (via the Sec. 965 “transition tax”) “deems” those undistributed earnings to be taxable (to the individual shareholder), as though they have actually been distributed. To put it simply: The United States imposes U.S. taxation on those “undistributed earnings” before they have actually been distributed.
5. Because the United States is imposing taxation on the “undistributed earnings” as though they were actually distributed, the United States essentially “beats Canada to the tax grab” (“front-running”) and receives tax revenue from the “undistributed earnings”.
6. By receiving tax revenue from the “undistributed earnings”, the United States is siphoning money out of the Canadian economy. (This is the “macroeconomic” effect of the “transition tax” and other forms of U.S. taxation imposed on Canadian residents).
7. As I have previously argued, Section 5 of Article 10 of the Canada U.S. Tax Treaty prevents the United States from imposing taxation on the undistributed earnings of Canadian corporations (for good reason).
8. By “beating Canada to the tax grab”, the United States will generate revenue from individuals in Canada that it would never have generated. Why? Because if the taxation had occurred ONLY upon an actual distribution to the shareholder, both Canada and the United States would have imposed taxation on those distributions at the same time. Both Canada and the United States would have imposed taxation on those distributions at the same time. The use of “foreign tax credit rules” (found in Internal Revenue Sec. 901), would result in the U.S. tax owed being largely offset by the Canadian tax paid, leaving little or no tax revenue for the United States to actually recover.
This is what Karen describes in the “interview excerpt” in the following tweet. I encourage you to listen to this:
Brilliant! @FinMusings explains how @USTransitionTax allows USA to collect tax on income that never would have resulted in U.S. tax payable! By changing timing and "frontrunning" USA creates a "fictional event" to tax CDN income before Canada can tax it! https://t.co/hnDu6x7y5K
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) April 4, 2018
To put it simply: Because of the U.S. policy of imposing worldwide taxation on the residents of other countries, many aspects of U.S. taxation result in the “confiscation” of assets located in other countries. The “transition tax” – by creating a “fictitious tax event” – is a timely and exceptionally brazen example of how this confiscation works.
“Fictitious tax events” and beating the country of primary taxing jurisdiction to the “grab”
The Sec. 965 “transition tax” is a tax that is (1) imposed retroactively and (2) without any actual “realization event”. In general, it is unusual to impose taxation without a specific realization event. Because, the Sec. 965 transition tax is in effect a “confiscation” that is not based on a “realization event”, I have compared the Sec. 965 “transition tax” to the “Offshore Voluntary Disclosure Program” (“OVDP). One might also (because there is no actual sale or purchase of assets) compare the Sec. 965 “transition tax” to the S. 877A Exit Tax. Both the Sec. 877A Exit Tax and the Sec. 965 “transition tax” are taxes imposed without any “realization event”. Notice also that the “Exit Tax” and the “transition” tax BOTH create “fictitious tax events”, which allow the U.S. to impose taxation, before the other country can impose taxation (because the other country imposes tax based on an actual event and NOT on a “fictitious event”).
By way of comparison:
The Sec. 877A Exit Tax would allow the U.S. to impose taxation on Canadian pensions before Canada would impose taxation on the pension.
The Sec. 965 “transition tax” would allow the U.S. to impose taxation on the “undistributed earnings” of Canadian corporations, before Canada would impose taxation on those earnings.
Note that both are examples of how the United States, by “imposing worldwide taxation on those who have tax residency in other countries”, has created an opportunity to (1) create “fictitious income” and (2) impose taxation on that “fictitious income”. As the Sec. 965 “transition tax” demonstrates, this results in the confiscation of assets located in those countries.
Do these preemptive U.S. tax strikes against the tax/capital base of other countries violate tax treaties? Do they violate international law?
This is a topic that requires further research and investigation. For the moment I will leave you with an article written by Oz Halabi in 2012 titled:
“Expatriation Tax – Renouncing A Tax Treaty”
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1961445
In 2012 the “transition tax” had not yet been invented. But, the Sec. 877A Exit Tax had been invented. Of interest at page 10 Mr. Halabi writes:
Although international law does not prohibit countries from imposing exit taxes on their residents, there could be situations where the levy of a tax on capital gains by a legislative fiction in one country infringes on a bilateral tax treaty.
In this respect, the Netherlands Supreme Court has ruled that the tax on a fictitious alienation in specific circumstances can be incompatible with treaty law. If a taxable event was allocated for tax purposes to one state, the other state cannot by a later legal fiction attribute taxing rights to itself regarding a purchase or alienation that did not occur.
Netherlands Supreme Court, 5 September 2003, No. 37,651
Hmmm …
Part 5 of Article X of the Canada U.S. tax treaty, specifically prohibits the United States from imposing taxation on the undistributed earnings of Canadian corporations. This means that the taxing rights to the “undistributed earnings” of Canadian Corporations are allocated to Canada under the treaty. The United States should NOT be allowed, through a later legal fiction (the Sec. 965 “transition tax”) to attribute taxing rights to itself to a distribution of earnings which did NOT occur.
This is just plain common sense.
You will find Mr. Halibi’s complete article and thought provoking article here:
Definitely food for thought …
I can’t read this stuff. I makes me feel nauseous. Mainly because no country does anything to stop this injustice and theft.
The solution proposed doesn’t seem likely to be effective:
Aid wouldn’t be needed if the US was the kind of country that gave a damn about the effects of its brutal tax laws on the people the money is extorted from. Since it doesn’t give a damn, it won’t be providing any aid for its intended victims. The extortion is intentional. Done on purpose, to get the money. Seems to be a concept the writer of the article is incapable of thinking.
The suggestion in BB’s recent post (to put pressure on the Chancellors/Treasury Ministers of the residence countries to raise the transition tax directly with Mnuchin) seems (to me) more promising. A lot of countries are not very happy about the recent tax reforms and tariffs of their partner-in-FATCA-crime.
Indeed it is. The saving clause lets the US skip around that by preserving America’s right to tax its citizens as it pleases.
As I understand it (being no lawyer but based on my common-sense interpretation of what I have read), the imaginary repatriation of the imaginary money doesn’t try to re-attribute the taxing rights on distributions of profits from Canada to the US. Instead, USC corporation owners/shareholders are told to give the IRS some of the money that (under US Subpart F tax law) they would have given the IRS since 1986 if they’d received the profits and if US tax law hadn’t allowed them an exemption. If the corporation survives, and eventually distributes whatever profits remain, Canada will have the taxing rights on the actually distributed profits.
The treaty doesn’t protect the USC owner/shareholder from the US demand, because the saving clause allows the US to tax its citizens as if the treaty had never come into effect. Of course it’s outrageous, but is it open to legal challenge? Was the Dutch case about US exit tax? Is there a link to the Dutch ruling?
There is a short recent thread about the transition tax in a UK forum. It may be of interest to those faced with the transition tax/GILTI tax dilemma.
Reply # 2 is from a tax advisor. If correct, could perhaps be helpful in relation to the GILTI tax.
http://talk.uk-yankee.com/index.php?topic=93372.0
Plaxy,
The saving clause doesn’t come into play here. The fact that the US is pretending that a distribution has been made to a US taxpayer does not change the fact that it is corporate undistributed profits that are being taxed. The corporation should be able to claim the benefits of the treaty to prevent its undistributed profits from being taxed by the US. And the corporation, not being a US citizen, is not subject to the saving clause.
Of course, the IRS will not agree. That doesn’t mean one should just blindly follow the IRS interpretation of the treaty. Canada has the right to interpret the treaty as well. While treaty partners may not have had the backbone in the past to stand up to the US on its extraterritorial taxation, the sheer audacity of the US claim to 15.5%+ of undistributed earnings of corporations owned by Canadian citizens may help bolster their resolve.
Karen – yes I agree Canada can raise transition tax concerns with the US. I hope as many countries as possible will raise transition tax concerns with the US (though it seems to me it would be much more effective to do so minister-to-minister rather than at “Competent Authority” level.
[My opinion only:
I think any individual who is facing the transition tax demand would be wise to protect themselves by deciding on a strategy a.s.a.p., rather than putting it off, gambling that the US can be persuaded by negotiation, or required by international law, to withdraw or mitigate its demand in the next couple of months. The fact that they got away with the exit tax business (even to the extent that most US treaties now explicitly state that the US can carry on taxing former citizens – which is nonsense) may suggest that they’re likely to get away with the transition tax too.
The USCs that are subject to the transition tax demand are those who have consented to the US’s right to treat them as owners/shareholders of a US Controlled Foreign Corporation by filing Form 5471. If they file 2017 taxes, they’ll have agreed to allow the IRS to decide whether they should pay the tax. So if they intend not to pay the tax – not even the first instalment – they need to not file US tax forms for the 2017 tax year or in future.
In other words, renounce or ignore. Not comply, ever again.
IMO]
Don’t volunteer. Unless that’s the option you’ve decided is best for you.
The 5471 is a whole other dilemma. Imagine you are a USC married to a non-resident alien who is an entrepreneur with a corporation in the country of residence. The USC has nothing to do with the NRA spouse’s business and the laws of the country stipulate separation of property, so the USC has absolutely no right to anything involving the corporation, let alone be considered a shareholder with a stake in the business. Why then, in such an example, would any USC volunteer information by filing 5471?!
It seems to me there is a great deal of uncertainty as to when to apply US law and when to apply local law. Sometimes it’s one and sometimes it’s the other. I faced this on my exit tax form. My husband owns everything and I was advised (Phil H.) that to calculate my net worth I can’t claim anything I don’t have a legal right to or stake in. So the US can deem all it wants, but it’s all just a charade. If I were caught in the transition tax nightmare I would not play the game, I would ignore it and never comply again.
The IRS doesn’t give a RIP what the actual law says. They write the Reg’s and accountants conform and taxpayers are as confused as ever because they have no ides what the tax law actually says.
We are so used to the Marxist’s in government shitting on us that we think it is fitting and normal.
Until this abomination is repealed or the SCOTUS declares it void for vagueness because the average couldn’t even know if they could conform, we will be slaves who were not freed by the 13th and 14th amendment to our constitution.
The FairTax would free all the slaves including the expats and the poor would pay no taxes as the do now with the Employment tax . Everybody would have a stake in the game and the founders would stop spinning in their graves because we have screwed their idea up so badly we may see the world have fire and brimstone rain down on the NEW SODOM AND GAMMORAH we’ve become.
@plaxy
“If they file 2017 taxes, they’ll have agreed to allow the IRS to decide whether they should pay the tax. So if they intend not to pay the tax – not even the first instalment – they need to not file US tax forms for the 2017 tax year or in future.”
The IRS is either going to enforce, or they won’t. Getting cute with them will not help.
I’m not a lawyer, but it doesn’t seem logical that filing forms and taking a position that the TT doesn’t apply constitutes consent. It’s only consent if you pay it.
BB – you may be right. If you file as if the transition tax doesn’t apply – not taking a treaty return position but just ignoring the transition tax – they may choose not to follow it up. It’s up to them. They can’t get Canada to assist in collection, so they might just accept it.
A person who opts to stop filing is not “getting cute”, they’re exercising their rights under the law of the land.
Likewise, a person who opts to renounce is simply exercising their right to renounce.
And a person who opts to pay the tax and stay compliant is also simply exercising their right to do so.
If a friend or relative of mine was facing this decision, I’d be urging them to renounce and get rid of America.
However, if you file and take a treaty return position that the transition tax does not apply, you’ll need to file 8833, and hope the IRS will accept it.
If they don’t accept it (and in my view there is zero chance that they will accept it), you can stop complying at that point, relying on the treaty provision that Canada will not collect from citizens. Or you can use the MAP procedures, i.e. let the two tax agencies come to an agreement as to whether or not double-taxing would be caused. The decision would certainly be of great interest but it’s a horrible risk to take.
No more risk than not filing, plaxy, and with the possible benefit of winning.
What risk do you foresee from not filing?
@plaxy
I didn’t go through the agony I did to put myself in the position to exit cleanly just to put myself in a worse position by stopping filing.
I’m going to put my faith in this TT situation resolving itself to my benefit, and walk out of thIs being able to renounce cleanly. If not, they can come after me.
#NotPayingThis
Filing a Form 8833 would accomplish nothing but draw unwanted IRS attention. Why stick your head up only to be pounded down? It seems to me the least risky course would be to not file anything, or to abruptly stop filing if you were previously attempting to be compliant. There is nothing to be gained by playing by the IRS rules.
Sure, there is a remote risk of a life altering penalty (which you would then ignore), but complying with this abomination would be life altering in and of itself so why even try. (Unless you want to be a test case, but most people aren’t interested in being a crash test dummy.)
Understandable, BB. I wish you luck.
Thanks, plaxy.
There are a lot of good people working in this. We’re going to beat this thing!
BB: I so hope you’re right! I wish Godspeed to everybody trying to fix this thing.
John & Karen: Thanks for everything you two are doing to educate our community AND the lawmakers who (in the U.S.) came up with this insanity and (in the rest of the world) have allowed them to get away with it. Up until now the victims have only been powerless individuals. Maybe . . . just maybe . . . since this time the U.S. is trying to get its greedy fingers on foreign *corporate* earnings the warning bells will actually be heard in such places as the halls of the Canadian Parliament. Perhaps we can dare to hope that the U.S. has unwittingly written the death-warrant for its extra-territorial taxation system all by itself. This situation cannot stand.
How are things going with the RBT/TTFI “fixes” that are supposed to be in the works this month?
Maz57: I agree that there’s no point committing financial suicide in order to avoid potential financial ruin. However, I think there is a middle ground – filing the return with no transition tax computations AND no 8833. There’s a chance that the IRS will not audit, but if they do, you can still claim a treaty position even if 8833 has not been filed (there is a penalty for failure to file 8833). Of course, you need to have a reasonable legal argument for your position – this is not something one should do without getting competent advice.
BB: I hope we do beat this – it is really the most egregious extraterritorial tax law the US has ever tried to impose. I wonder how much enforcement effort the IRS will bring to bear, as strict enforcement will demonstrate to all that CBT is unworkable.
MNM: Thanks for your kind words. As for RBT/TTFI – there is a meeting scheduled later this month (reported in the American Expatriates group on FB). I’m sure there will be updates when there’s something to report.
@karen
Thank you. That sounds like a reasonable plan. Those who can’t or won’t pay this tax will either stop filing or not pay the tax. What other options are there?
FYI, “Failure to include Form 8833 can result in a $1,000 penalty for each year you fail to disclose your treaty position. … As one of the IRS disclosure forms, your 8833 is attached to your US tax return to show the IRS that you are properly complying with the treaty provisions that apply to you.”
Stupid question: how does the IRS know that somebody living abroad owns a foreign corporation if it is not reported?
BB – just be careful. Remember they can’t afford to turn a blind eye, once you’ve filed. There’s too much riding on this, for them.
To file, providing the information required of 5471 filers, and then invoke the MAP procedures (being prepared to lose and pay), could be a good plan, it seems to me, if the filer was planning to renounce and wanted a clean exit. Provided the filer is aware that losing means paying, the MAP procedures could at least lead to a decision on the double taxation issue. (The filer, of course, would not be involved in the process; there would be no opportunity to argue the case. More info at https://www.irs.gov/individuals/international-taxpayers/competent-authority-arrangements)
To file and claim exemption is not a good plan, it seems to me, because regardless of whether 8833 is filed, there would have to be a valid basis for claiming exemption. Otherwise, the IRS can simply require the missing information to be supplied. There isn’t a basis for claiming exemption, and the MAP procedures don’t offer a route for claiming that there is.
US taxpayers have few rights. Best not to be one, unless you’re prepared to play (and pay) by their rules, or can afford to pay the likes of Rettig’s firm to make sure you come out on top.
Good luck, whatever you decide. It’s a rotten way for a country to treat its decent taxpayers. Thieving bastards.
maz57:
Completely agree. Though if a person wants to renounce and file final forms, avoiding covered expatriate status, paying the transition tax could facilitate that – as suggested by that tax adviser.
Completely agree. There’s no glory in being the sacrifice.