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 …
@plaxy
You can call it scaremongering if you wish, but I think it is helpful to consider all situations before making any decision. Fred asked the question, I gave him a possible situation.
Yes, you can dispose of all shares before moving back but it would be on your IRS record that you once had a unreported foreign Corp account reported by a foreign bank. If someone is ‘compliant’ the question could be asked at any time on an audit.
For those who have no intention of ever working there again, I agree, it would not be an issue.
@plaxy
I just want to add that I have no idea if Fred has a foreign Corp but if he ever does have it is important in his situation, that as a ‘compliant’ US citizen he considers the possibility that it could be reported by his bank. That is not scare mongering, it is just good sense.
“You can call it scaremongering if you wish, but I think it is helpful to consider all situations before making any decision. ”
It’s not actually dangerous though and isn’t what was asked. The IRS doesn’t have extraterritorial powers, and moving back to the US can perfectly easily be arranged without any danger, should the owner of a foreign corporation decide that that’s what they want to do. Same as your adult children aren’t trapped. It’s perfectly easy to leave the US, though not necessarily so easy to settle elsewhere these days – a problem which has got nothing to do with the IRS.
“I have no idea if Fred has a foreign Corp”
Me neither.
“if he ever does have it is important in his situation, that as a ‘compliant’ US citizen he considers the possibility that it could be reported by his bank.”
I think Fred’s aware of FATCA.
US Person accounts may get reported to the IRS. Is this something USCs need to be scared of? I don’t see why. It’s outrageous and a damned nuisance because it limits access to financial services but it’s not scary.
The idea that USCs living outside the US have to live in fear of the IRS is demonstrably untrue. Many of us lived away from the US for decades without ever giving a thought to the IRS.
Comply, ignore, renounce. FATCA does not change the options.
@ Plaxy
We are splitting hairs here, what was asked was a simple question
“Stupid question: how does the IRS know that somebody living abroad owns a foreign corporation if it is not reported?”
Answer is simple.
The banks might tell them. In Fred’s case it is something to bear in mind.
My kids are trapped in the respect that one was considering buying a house abroad as a holiday home and to also retire there someday, (they also have British Passports with US birthplaces)and as US citizens, no bank will take their money if they are not resident.
Another was applying for a job in Europe and was told they need an EU passport. Yes agreed, that is not entirely a US citizenship problem.
“The idea that USCs living outside the US have to live in fear of the IRS is demonstrably untrue. Many of us lived away from the US for decades without ever giving a thought to the IRS.
Comply, ignore, renounce. FATCA does not change the options.”
Agree, renounce is the KEY word.
“We are splitting hairs here, what was asked was a simple question
“Stupid question: how does the IRS know that somebody living abroad owns a foreign corporation if it is not reported?”
Answer is simple.
The banks might tell them.”
The banks don’t though. The banks report accounts, they don’t write to the IRS pointing out that Joe the Australian USC Plumber owns a corporation. Joe already knows his accounts may be reported to America, if his bank has asked him to sign a W-9. He doesn’t need to be warned that the IRS could “get him” if he moves back to America.
“My kids are trapped in the respect that one was considering buying a house abroad as a holiday home and to also retire there someday, (they also have British Passports with US birthplaces)and as US citizens, no bank will take their money if they are not resident.”
So residence is the issue – not the IRS. If they retire to Europe they’ll be able to open a bank account. They’re correct in not seeing themselves as trapped.
“Another was applying for a job in Europe and was told they need an EU passport. Yes agreed, that is not entirely a US citizenship problem.”
It’s not a US citizenship problem at all.
While FATCA reporting can be a problem, I don’t think it’s likely to “out” a truly active corporation. First, entity accounts are only reportable if the entity itself is tax-resident in another country – a CFC is, by definition, not a US tax resident. FFIs are only required to look through the corporate entity if the entity is a “passive NFE”, which is an entity that has more than 50% of passive income or assets (and is not a financial institution, publicly traded corporation, or government entity). For a passive NFE, the FFI must identify a natural person who is the ultimate beneficial owner or controlling person. Where you have a foreign trust, the beneficiaries and the settlor are considered controlling persons. If the controlling person is a reportable person (US person for FATCA), then the account is reported. Mere signature authority by a US person is not sufficient to make an entity account reportable.
So, if a CFC is running an active business (which is what the transition tax is targeting), then it will not be a passive NFE, and it will not be FATCA reportable. If the CFC has more than 50% passive income or assets, then it will have been reporting subpart F income (if US-compliant), which reduces the retained earnings subject to the transition tax. In this case, the beneficial owner of the CFC will be a reportable person and the account will be reported under FATCA. If there is no beneficial owner (AML/KYC rules determine this), then the most senior manager is considered the beneficial owner.
That’s very interesting, Karen. Thanks for the clarification.
Karen:
“a CFC is, by definition, not a US tax resident.”
So presumably that’s why the US invented the Subpart F business – another way to make USCs report and pay tax on non-US-source income if they want to retain “US-tax-compliant” status.
@Karen
Thanks.
I was thinking how it would affect a small private medical practice of a ‘compliant’ US person.
“I was thinking how it would affect a small private medical practice of a ‘compliant’ US person.”
Correct me if I’m wrong but if the US person is not complying to the extent of reporting the corporation himself/herself (by filing 5471), and the bank is not reporting the corporation because it’s not reportable, then surely the corporation is not being reported.
If it is being reported, the owner will know (if resident in a Model 1 jurisdiction, because s/he will been asked to sign a W-9 and fetch a US TIN for the corporation.
@Plaxy
“If it is being reported, the owner will know (if resident in a Model 1 jurisdiction, because s/he will been asked to sign a W-9 and fetch a US TIN for the corporation.”
But this would be something to bear in mind before branching out into a private medical practice ‘abroad’
“this would be something to bear in mind before branching out into a private medical practice ‘abroad’ ,
What? FATCA?
If I’ve understood Karen’s comment correctly, it’s not a problem. Just tell your children not to file 5471.
If anyone is still on the fence about whether or not to renounce, this website may help you with your decision:
https://papersplease.org
The last few posts have been extremely disturbing, please read them. Get out while you still can.
…
Will “continuous vetting” include new demands for travel information?
Congress is currently considering multiple “immigration” bills containing provisions for “continuous screening” or “continuous vetting” of foreign residents, visitors, and would-be visitors to the US. As we have noted previuosly, “continuous screening” and “continuous vetting” are euphemisms for “continuous surveillance and control”.
These so-called “immigration” bills would not be limited to foreigners. Many of them would include US citizens exercising our right to leave our country, and to return, in pre-crime travel surveillance and control schemes. ….
—
Now I am thinking that besides being used as slaves paying into social security taxes to prop up a generation of older americans, immigrants are also being used as an excuse for creating an outright police state! Geeze, no wonder hollywood propaganda and brainwashing has been so intense for generations to make people all over the world believe that USA people are actually free. This is beyond money and FATCA CBT, retirements and financial ruin- those are small problems compared to truly being owned.
KingoftheRoad: Thank you for the JAMA link. I will check that out and include it in the next UN communication.
I said:
“plaxy says
April 7, 2018 at 5:03 am
This would be good:
”
Unfortunately, thinking about it further, this presumably wouldn’t apply because the treaty specifically does allow the US to tax its citizens as if the tax treaty had never been signed (bar the handful of exceptions), with no entitlement to residence-country credits for the US tax paid.
Asking the Treasury Minister to take up the issue directly with Mnuchin does seem more likely to have an impact. Clearly it’s not in a residence-country’s national interest to have small businesses going bankrupt as a result of this absurd retroactive taxation by the US of income which does not exist. At Ministerial level, the discussion of this problem would not be confined by artificial limits such as “not in accordance with the tax convention.”
“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.”
People misunderstood the point I was trying to make. There is no doubt that the IGAs demonstrate that the world has acknowledged the US’ right to tax its citizens and that having a US birthplace is the most common indicator of US tax residency.
However, even with a US birthplace, obtaining a CLN will permanently eliminate the US tax residency problem everywhere but in the US itself. Fictional tax citizenship which lives on even after actual citizenship has been lost only exists on US soil. The average foreign bank doesn’t give a damn about the subtleties of US exit tax law or what the person filed or didn’t file after they lost US citizenship; its not their problem. Once they confirm the CLN, the indicia can be “corrected”, the bank is off the hook, and the person will be afforded the same financial freedom as any other non-US person. The fact that many have renounced, filed nothing, and suffered no adverse consequences is proof enough of that.
(We here in Canada are especially lucky because according to our IGA a “reasonable explanation” will suffice even if a CLN isn’t produced. I guess it boils down to how convincing you can be with the individual bank employee.)
“even with a US birthplace, obtaining a CLN will permanently eliminate the US tax residency problem everywhere but in the US itself. Fictional tax citizenship which lives on even after actual citizenship has been lost only exists on US soil. ”
Yes I agree. Though the same is true of CBT itself, at least in Model 1 IGA jurisdictions. The birthplace causes a problem with bank access – not with tax, either for USCs or former USCs.
“We here in Canada are especially lucky because according to our IGA a “reasonable explanation” will suffice even if a CLN isn’t produced.”
They all do (Model 1 IGAs). It’s the local legislation that binds the bank. Local legislation here doesn’t require a bank to give an account to a US-born applicant clutching a CLN.
And, thinking about it, that’s perhaps where the tax-citizenship comes in. After all, I could be a ===>COVERED EXPATRIATE<===. Evilly trying to open a foreign unreported bank account in which to hide my savings. There goes the FATCA Compliance Officer’s bonus.
There was some noise being made awhile back of banning “covered expatriates” from entering the USA. (This might not have applied to Canadians, I dunno.) This raises the interesting question of how the border guards can know whether any particular person is a covered expatriate. Would they use the combination of name and birth data? (But names can be changed.) Surely the ID numbers wouldn’t be linked. And facial recognition technology would only work, if they could link your face to your old SSN.
Eh?
Covered expatriates volunteer for that status by filing the 8854 listing their itemized worldwide assets, pretending they’ve cashed it all in so they can go sharesies with America. Having voluntarily provided America with all that data and signed up for the donation, why would they lie about it on a visa application? And why would America want to keep them out, when they’ve already got them under contract to pay up?
Maybe it would be first name and last name. That’s how they get babies onto the no-fly list.