Liberty and justice for all United States persons abroad

The Isaac Brock Society

Posted on by Posted in Non Resident Taxation, Transition Tax 118 Comments

 

cross posted from citizenshipsolutions

    by John Richardson
 

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 1: Responding to The Section 965 “transition tax”: “Resistance is futile” but “Compliance is impossible”

Part 2: Responding to The Section 965 “transition tax”: Is “resistance futile”? The possible use of the Canada U.S. tax treaty to defeat the “transition tax”

Part 3: Responding to the Sec. 965 “transition tax”: They hate you for (and want) your pensions!

Part 4: Responding to the Sec. 965 “transition tax”: Comparing the treatment of “Homeland Americans” to the treatment of “nonresidents”

Part 5: Responding to the Sec. 965 “transition tax”: Shades of #OVDP! April 15/18 is your last, best chance to comply!

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:

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:

SSRN-id1961445(1)

Definitely food for thought …

John Richardson

118 thoughts on “Part 7: Responding to the Sec. 965 “transition tax”: Why the transition tax creates a fictional tax event that allows the U.S. to collect tax where it never could have before”

  2. This would be good:

    15. Although not under the category of a “typical request,” the Canadian Competent Authority may initiate competent authority proceedings and subsequent negotiations without a specific request from a taxpayer in any situation where there is taxation not in accordance with a tax convention in order to protect Canadian interests. For example, the Canadian Competent Authority may disagree with the interpretation by its treaty partner of a provision in a tax convention. Such a situation could involve a specific taxpayer or a group of taxpayers. In either case, the Canadian taxpayer(s) will be advised of the competent authority proceedings and outcome. Moreover, a taxpayer maintains the right to reject a competent authority agreement reached in such a situation. (See paragraph 55.)

  5. plaxy:

    It seems to me that the best course of action for those who renounce would be to file the final partial year tax return and a Form 8854 that doesn’t even mention the problem corporation. (Or alternatively, don’t file anything at all.)

    (As in: “This new transition tax is so ruinous that I thought it couldn’t possibly apply to someone like me so I just ignored it”.)

    Establish average tax liability is below the threshold, certify 5 years of compliance, do a minimal net worth calculation, and toss it in the mail. Done and dusted.

    Once the IRS receives the 8854 (plus notification from the State Dept.) they know a few things about that person that they didn’t know previously:
    1. The person is not only a resident taxpayer of another country, they are a citizen of that country.
    2. The person is no longer a US citizen.
    3. The person will never have any further interaction with the IRS.
    4. There will be no FATCA information flowing to the IRS.
    5. Its now so difficult to go after that person that it has become a practical impossibility.

    As far as I can tell, the IRS totally gives up once a person has renounced. I’ve never heard of anyone being hassled beyond that point, regardless of what they file or don’t file. The US may have their ridiculous fictional tax citizenship but the rest of the world doesn’t recognize that fiction. In the rest of the known universe you are either a US citizen or you are not a US citizen, and once you are not a US citizen the IRS will get no help whatsoever from any foreign bank or government. (All of this assumes, of course, no US assets because that is the only possible leverage the IRS could have after one has renounced.)

  6. maz57 – I agree that once a person has renounced, they’re no longer in danger from the US, as long as they keep clear of the US and provided, as you say, they have no US assets. But that might not be what the person wants, if they have ties to the US and have complied with US tax law (perhaps at considerable cost) right up to the point where the US made compliance impossible. A person in that position might want to maintain their standing and make a clean exit.

    Whereas I take satisfaction in not having paid the US a penny since I left. 🙂

    A lot depends on how the person feels about America, I suppose.

  7. Mods: Not sure if this is the best place to give this comment… The effects of the Transition Tax comes on top of the devastating penalty-based sanctions the IRS imposes on individuals via its extraterritorial policies. The Journal of the American Medical Association published (3 April 2018) the results of a longitudinal study involving thousands of individuals, revealing the impact, in terms of excess mortality, that arises from a “negative wealth shock” (i.e., when a middle-aged person suddenly loses a substantial and significant portion of their assets). OVDP was not mentioned, but it sprang immediately to mind. See https://jamanetwork.com/journals/jama/article-abstract/2677426?redirect=true
    Perhaps this might be of use in the legal case(s) being brought against FATCA, or in the human rights case, as a demonstration of the likely harmful consequences on a large population of overseas Americans?

  8. Once a person has been forced to renounce US citizenship their feelings about America are not likely to be in the warm and fuzzy category. No one that I know feels anything but disgust and revulsion after going through the meat grinder. Personally, I don’t want any “standing” with the US; what I want is for them to be permanently out of my life.

    But for those who wish to make a clean exit (as if such a thing exists), minimal exit filings which sidestep the transition tax issue seem like they would do the trick. I guess my advice would be: “Go ahead file something if you feel you must but for God’s sake don’t send them any money”.

  9. “Once the IRS receives the 8854 (plus notification from the State Dept.) they know a few things about that person that they didn’t know previously:
    1. The person is not only a resident taxpayer of another country, they are a citizen of that country.”

    If the person filed a completed Form 2555 then the IRS already knew it. Form 1116 used to demand the same information but the IRS fixed it a few decades ago; Form 2555 still needs fixing.

    “2. The person is no longer a US citizen.”

    Or no longer a green card holder, etc.

    “3. The person will never have any further interaction with the IRS.”

    Not true.

    “4. There will be no FATCA information flowing to the IRS.”

    We don’t know if that’s true. A financial institution might see a US birthplace, might not care about a CLN, and might report.

    “5. Its now so difficult to go after that person that it has become a practical impossibility.”

    Not true.

    “As far as I can tell, the IRS totally gives up once a person has renounced.”

    Haven’t you seen some counterexamples?

    “In the rest of the known universe you are either a US citizen or you are not a US citizen, and once you are not a US citizen the IRS will get no help whatsoever from any foreign bank or government.”

    I don’t think that’s true either. As far as we can tell, if Dewees had renounced US citizenship and become stateless, CRA still would have collected for the IRS. Hypothetically if I were to renounce Canadian citizenship (whether or not I wanted to be Japanese), CRA would start helping the IRS.

  10. maz57 – “Once a person has been forced to renounce US citizenship their feelings about America are not likely to be in the warm and fuzzy category. ”

    I expect a lot of renouncers – maybe most – don’t have any feelings at all about America and are just doing what’s necessary to keep their financial affairs in order.

    Others, including me, have good reason to have strong feelings about America but it didn’t start with FATCA and it didn’t end with renunciation.

    And others, clearly, may feel connected to America, and that too presumably doesn’t end with renunciation.

    “The US may have their ridiculous fictional tax citizenship but the rest of the world doesn’t recognize that fiction.”

    I wish. The entire globe has signed up to the belief that anybody born in America is tax-resident in America forever and probably cheating their taxes.

    ” In the rest of the known universe you are either a US citizen or you are not a US citizen, and once you are not a US citizen the IRS will get no help whatsoever from any foreign bank or government.”

    They’ll still keep picking out the birthplace. Renouncing doesn’t make that go away. But it may be changed by at least some residence countries, eventually. Fingers crossed.

  11. @FredB
    “Stupid question: how does the IRS know that somebody living abroad owns a foreign corporation if it is not reported?”
    Perhaps from FATCA Bank reporting of foreign Corporation account if owned by US person.?

  12. The transition tax presumably only affects foreign corporations if there’s a USC owner or shareholder who has been filing 5471.

  14. @ Plaxy
    Surely any account which has a US person listed will be reported by the bank regardless of filing a 5471.
    I have never owned a corporation, have always had academic posts so not sure but
    it was reported the CEO of a Swiss hospital had to renounce his American citizenship to keep his position.
    Also wasn’t there a group of Bell ringers in the UK who had to prove to the bank they didn’t have any US persons on their rotating board of directors?

  15. Heidi – the pretended justification for the transition tax is the deferral of US tax. As I understand it, the deferral is claimed by filing 5471. Logically, the only USCs who will have difficulty filing a 1040 for 2017 without mentioning E&P since 1986 are those who’ve previously asked for the deferral, by filing 5471. Somebody please correct me if that’s wrong.

  16. @Plaxy
    I thought Fred was asking a general question, “how would the IRS even know you had a foreign Corporation”
    Unrelated to the transition tax, if you had never filed anything, the bank may still report the Corporation account if the find a US person with signature authority over the account, this would then open up a can of worms.

  17. “Unrelated to the transition tax, if you had never filed anything, the bank may still report the Corporation account if the find a US person with signature authority over the account, this would then open up a can of worms.”

    In what way?

  18. @Plaxy
    Letter from the IRS
    “We see you have a Corporation account, as reported by Bank X, please give us details of past activity”
    Fred asked “How would they know the existence of the Corporation”
    FATCA bank reporting will give them the basics.

  19. “The US may have their ridiculous fictional tax citizenship but the rest of the world doesn’t recognize that fiction.”

    “I wish. The entire globe has signed up to the belief that anybody born in America is tax-resident in America forever and probably cheating their taxes.”

    Seconded.

    It is part of the witches brew that has lead to this situation. For example, this subject came up a in British pub recently (the barmaid is American) and it simply blew me away that a group of British citizens nearly fell over themselves to justify the taxation of American citizens abroad by the USA.

    “They’re Americans, that’s the way it is”.

    And to be honest, they really were not interested in the human rights abusing monstrosity that is resulting or in the fact that they were paying for it.

    There is little to no sympathy for the victims, “they made their bed and they need to lay in it.”

    Renounce, ignore, do what you can to avoid the discrimination and above all, don’t send the bastards one single cent.

    PS- I intend to write the Freedom House and ask why they continue to ignore FATCA, the U.S tax code and the persecution and discrimination faced by U.S. citizens who wish to leave the USA when they compile the freedom index, instead preferring to just say that Americans are “free to travel”.

    Anyone else know if these people have faced the same question before?

    “Citizens of the United States enjoy freedom of movement and a high level of personal autonomy.”

    Somebody tell them……

  21. Though in fact I haven’t seen any reports anywhere of the IRS writing to a complying USC outside of America saying “we see you have this or we see you have that because your bank told us so.”

    If anyone knows of an instance of this happening, please do post a link.

  22. @Plaxy
    “Though in fact I haven’t seen any reports anywhere of the IRS writing to a complying USC outside of America saying “we see you have this or we see you have that because your bank told us so.”
    So far….
    but there is gold in those Corporate hills
    @ Mike
    Yes, that’s the reaction I get when I try to explain to the general public.
    My US resident kids close their minds to the knowledge they are trapped, they either refuse to believe or don’t wish to know the truth. I have given up.

  23. Heidi –

    “there is gold in those Corporate hills”

    Indeed, and the USC is the key that unlocks the little elvish wooden door in the hillside. But only if the USC gives consent.

  24. @Plaxy
    “Indeed, and the USC is the key that unlocks the little elvish wooden door in the hillside. But only if the USC gives consent.”
    True, but I believe FredB has decided to keep his US citizenship for the time being (and is ‘compliant’) for the choice/possibility of returning to work there again someday. The fact that the IRS have been alerted to the fact he may have an unreported foreign Corporation, it would not bode well should he return to the fold.

  25. Sorry Heidi but that’s just scaremongering. A USC who decides to move to the US has every opportunity to decide whether to dispose of a non-US corporation, or shares in a non-US corporation, before moving. If they keep the shares or the corporation, they’ll be subject to tax according to whatever treaty arrangements are in place between the US and the corporation’s country of residence.

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