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 …
“And why would America want to keep them out, when they’ve already got them under contract to pay up?”
You mean like they did to Roger Ver? Maybe because honesty is illegal in the US.
He was blocked in order to keep him from attending a blockchain conference, wasn’t he? The US suspected him of not telling them how much money he had in blockchain, knowing they couldn’t figure out how it worked.
The moral of that is, don’t confront America with something they can’t count. It makes them jumpy. Give them the cash, smile apologetically, and they’ll probably let you in.
Or you could get wait till an election year comes along and ask the Republicans to petition themselves to let you in.
@Plaxy,
Zla’od is probably referring to this ridiculous and vindictive law, proposed (apparently in all seriousness) by our old friend Chuck Schumer in 2012: https://en.wikipedia.org/wiki/Ex-PATRIOT_Act
So America, or at least the Dem portion of it, seems to want to both keep covered expatriates out and make them pay more. Or perhaps it’s either/or — hard to tell. Spectacularly poor lawmaking either way, anyway.
As for Ex-PATRIOT’s practicality… well, for more see proposals for Reed Amendment enforcement, I guess.
Watcher – thanks, that (plus ND’s De Ver reminder) explains it. Schumer was apparently assuming that renouncers didn’t have any choice but to accept their C.E. label, hand over their retirement, and be grateful they weren’t being shot.
A chap called Ness is coming along shortly to explain why this fuss about FATCA and CBT is all wrong, TurboTax has it covered.
Actually the bluster of Schumer’s threats (30% withhoding? that’s the same as NRA SS withholding) effectively acknowledges that the US can’t make a NRA tax-resident in the US by making a US law declaring that they are.
If they had the power to enforce the punitive taxation of the covered expatriate regime the US property would have been pre-taxed, on the day before R-day while the owner was still a captive..
So he does know he can’t do it. That’s probably what makes him so cross. 🙂
plaxy: “Covered expatriates volunteer for that status by filing the 8854 listing their itemized worldwide assets…”
I thought one way to be a covered expatriate is to NOT file the 8854 and/or 5 years of returns.
Zla’od: By what magical transmutation could the US make a NRA subject to punitive US taxation through use of a label?
They can’t tax a NRA on non-US-source income or assets as punishment for not submitting a 8854, because they have no legal power to do that.
They can refuse entry clearance or visa though, or slap a lien on US property.
Which, if a person wants to be able to visit the US post-renunciation, or has US assets, may be a good reason to file the 8854 – either a minimalist 8854, as maz57 suggests upthread, or if liked, a full-on “here’s my money” 8854.
IMO.
Another reasonable reason for volunteering for the exit tax might be if the person believed it was the right thing to do.
But in that case s/he would presumably not be looking to avoid it, and would just file and pay.
Being refused entry is my worry. I have elderly parents there.
Would a “minimalist” 8854 include the filer’s SSN? Perhaps they can’t process it without one. Of course many renunciates will lack one. On the other hand, it must be hard to link the files of a “covered expatriate” with no SSN, especially if their foreign-country passport gives a different name than the renounced US passport.
Zla’od – I’m not sure you could file the 8854 without a SSN. Phil Hodgen discusses this in his blog series https://hodgen.com/category/expatriation-chronicles-of-an-accidental-american/
and in a later entry https://hodgen.com/expatriation-with-no-social-security-number-another-report-from-the-trenches/
But they’re talking about someone who’s still a citizen. And Hodgen is obsessive about doing everything by the book, so he won’t be suggesting any alternatives.
Someone from Canada might have a suggestion (e.g. fly to Canada and enter by land?)
Does the application actually ask if an 8854 has been filed? If not, there should be no problem.
If they want to ban former citizens who haven’t filed an 8854, they’ll presumably ask that question before they let you set foot on a US-bound flight. If they don’t ask the question then, it seems unlikely they would ask it later.
“it must be hard to link the files of a “covered expatriate” with no SSN, especially if their foreign-country passport gives a different name than the renounced US passport.”
Indeed. Might be worth considering entering as a foreigner rather than as a former citizen? I’ve no idea if that would be a good idea or a terrible idea.
@Zla’od
plaxy: “Covered expatriates volunteer for that status by filing the 8854 listing their itemized worldwide assets…”
I thought one way to be a covered expatriate is to NOT file the 8854 and/or 5 years of returns.
Just to clarify, filing a Form 8854 supplies the IRS with the information they need to determine whether or not a person is a covered expatriate. A person who doesn’t file the form hasn’t given the IRS the necessary information so the person winds up in a state of limbo. The IRS doesn’t have the information to classify them one way or the other.
This situation just illustrates the ridiculousness of it all. If the IRS were to do its own snooping on a person (a virtual impossibility because the person is outside of the US) only to determine that they were non-covered, no exit tax would be owing so that would make it a pointless exercise. If, on the other hand, their research determined that the person WAS covered, they would have no way to collect exit tax so it would still be a pointless exercise.
I think the IRS knows perfectly well that they have absolutely no leverage once a person has renounced and that’s why no one ever hears anything from the IRS again, regardless of what they file or don’t file. That person is gone and is forever beyond the reach of the IRS. I doubt they even look to see if a Form 8854 is filed let alone read one of the damn things. Why somebody would file a Form 8854 that established that they were a covered expat is beyond me.
The only situation I can imagine where a person might want to file 8854 would be if they still owned residual US assets and they wanted to establish they were not covered.
Or had family in America, as in Zla’od’s case.
@ maz57
“… the person winds up in a state of limbo.”
Ah yes, the infamous state of limbo. I know it well. It used to make me cringe but now I just shrug. Maybe it’s because the current state of Syria is more on my mind today. Israel is itching to pull the US trigger to get WW3 going by using a false flag chemical attack as a means to “justify” their diabolical ends. It’s a very tense time and one can only hope Russia will pull off yet another save. Certainly we can’t look to the Western World for any sanity these days. (Sorry for going OT but this worry is overpowering the worry of taxation vexation.)
So do I; so far, so good. No problems whatsoever.
What is this state of limbo being discussed here? The IRS states clearly in its publication that failure to file the 8854 will automatically trigger covered expatriate status.
Plaxy – If you try to act to the USCIS as someone who never had US citizenship when you did, or try and change your name to conceal that fact, you’d probably be banned (maybe forever) from entering the US for lying/deception if they ever found out (much like for example someone who didn’t reveal a material criminal history).
Kelly – thanks for the warning. Any suggestions as to how Zla’od can visit his parents?
Petlover – “The IRS states clearly in its publication that failure to file the 8854 will automatically trigger covered expatriate status.”
A non-event, if no action follows.
@Petlover
“What is this state of limbo being discussed here? The IRS states clearly in its publication that failure to file the 8854 will automatically trigger covered expatriate status.”
Where did you read that? If you’ve found something I’ve missed please let us know. The only thing I can find in the instructions for 8854 says this:
“You are a covered expatriate if you expatriated after June 16, 2008, and any of the following statements apply: (1 and 2……..the usual average tax liability and net worth amounts)
3. You fail to certify on Form 8854 that you have complied with all federal tax obligations for the 5 tax years preceding the date of your expatriation.”
Obviously, if you don’t file Form 8854 you can’t possibly “fail to certify” something on a form that you didn’t file. It does say that failure to file the form on time carries a $10,000 penalty but apparently that only applies if you are a covered expatriate, not to regular expatriates. But if you don’t file the form the IRS doesn’t have a clue what kind of expat you are, let alone whether or not they should assess the $10,000 penalty. It seems to be a case of a badly written law, a badly written form and badly written instructions to boot. Hence the state of limbo.
Hodgen has a fun write-up about all this on his blog here: https://hodgen.com/blog/page/4/
Naturally, he recommends arranging things so you are not a covered expatriate and filing the form even if you file it late.
Full disclosure: I’m a natural born refusnik and I’m willing to take the risk of being permanently banned from the US. I think the risk of that happening is very minimal but certainly not zero. Hell, who knows, its possible all Canadians will automatically be banned when pot is finally legalized. The US government is capable of anything and can unilaterally change the rules anytime they want. I’m not even sure US citizens are guaranteed entry at this point in time.
Kelly: ” If you try to act to the USCIS as someone who never had US citizenship when you did, or try and change your name to conceal that fact, you’d probably be banned (maybe forever) from entering the US for lying/deception…”
I was born there, so this wouldn’t work anyway. A name change might discourage them from linking my passport name with the name on the list of covered expatriates.