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 …
Maz57: “Obviously, if you don’t file Form 8854 you can’t possibly “fail to certify” something on a form that you didn’t file.”
At the risk of stating the obvious, I assume that failure to submit the form at all would be interpreted as failure to certify something on said form! An interesting question is whether one might get away with submitting only 8854, but not the 5 years of returns (whose filing may not have been required). And what effect would submitting 8854 without an SSN have? (Some people never got them.) Perhaps the IRS would be unable to process it, leaving the filer stuck on the list of covered expatriates?
plaxy: “Does the application actually ask if an 8854 has been filed? If not, there should be no problem.”
You mean the visa / visa-free entry application? No, at least not yet. I understand that they do ask for your social media accounts, though (no blank for Brock, unfortunately!) so who knows what they may want in 5 years.
Zla’od: “At the risk of stating the obvious, I assume that failure to submit the form at all would be interpreted as failure to certify something on said form!”
I wouldn’t assume anything when it comes to the IRS. If they really intended to automatically treat someone who didn’t file the form as a covered expat they would have said exactly that somewhere in the instructions. The more likely explanation is that they never imagined that someone would skip filing the form and that lack of imagination created in a vague gap in the rules.
I have no idea what effect filing with no SSN would have but it would be fun to try it. Who knows, it might be a way to seize up the system! Unfortunately, I’ve got a number so I can’t be the guinea pig. I’ll just have to stick with not filing anything with the bastards.
As for certifying the 5 years without actually filing the 5 years because they weren’t required to be filed, I have heard of some who have done exactly that and had no problems. Hodgen advises folks to file ’em anyway just to cover all bases. I read somewhere about a person who renounced, sent nothing but a single Form 8854 to the Pennsylvania address, and has heard nothing since from the IRS. Like I said before, I don’t think it matters one little bit. Renounce and you are home free.
@maz57
I interpret the certification “on Form 8854 that you have complied with all federal tax obligations for the 5 tax years preceding the date of your expatriation” the same way as Zal’od does, namely “that failure to submit the form at all would be interpreted as failure to certify something on said form!” After all, you are guilty of form crime for failing to file any given form, whether or not you were even aware of its existence.
“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.”
A person who doesn’t file the form winds up as a covered expatriate. The IRS doesn’t need information and doesn’t need to make that determination.
You can stop being covered by going through a TSA X-ray, but the IRS will screw you whether you’re covered or not.
…
‘Obviously, if you don’t file Form 8854 you can’t possibly “fail to certify” something on a form that you didn’t file.’
If you don’t file Form 8854 then you fail to certify on Form 8854 everything that’s on Form 8854. (Logically that leaves open the possibility that you could certify the same information on other forms, but you’re failing to certify it on Form 8854.)
Well, going by the above logic that means one could convert their covered status right back to non-covered status by filing a Form 8854 10 years late. Makes no sense to me, but I’ll be the first to admit most of the US tax system makes no sense. As for IRS form crime, that may exist in the US but its not a crime anywhere else in the world.
An interesting discussion but in the end its all moot because the IRS is totally powerless once a person has renounced. The proof of that is nobody ever hears anything from the IRS once they have renounced regardless of what they file or don’t file. I guess I’m a potential “covered form criminal with an outstanding $10,000 penalty” but I’m not losing any sleep over it because I don’t believe the IRS has decided anything at all about me. If and when they make a determination I’m sure they’ll let me know.
Geeze folks, the IRS is the organization that regularly sends 500 tax refund cheques to the same address in Florida. Does anyone here seriously believe they are going to chase down international form crime?
“Well, going by the above logic that means one could convert their covered status right back to non-covered status by filing a Form 8854 10 years late.”
If I understand correctly, Phil Hodgen thinks that is possible. No one knows if it’s a good idea or not. My feeling is that the US government and courts would likely penalize a person who obeys the law in that manner unless the person can afford a very good lawyer.
“but I’ll be the first to admit most of the US tax system makes no sense.”
No you won’t. You’re 100 years too late to be first.
“the IRS is totally powerless once a person has renounced.”
I doubt it. If Dewees had taken Canadian citizenship, CRA still would have collected for the IRS for the period before Dewees taking Canadian citizenship.
“The proof of that is nobody ever hears anything from the IRS once they have renounced regardless of what they file or don’t file.”
Around 6 suitcases full of documents disprove that. Maybe they wouldn’t waste time chasing down international form crime because they’re too busy robbing and framing innocent victims internationally.
Dewees first mistake was not becoming a Canadian citizen. His second mistake was not renouncing US citizenship after not making the first mistake. His third mistake was sending the IRS money. Additional multiple mistakes trying to be compliant. If I recall correctly, he hoped he could successfully argue his case in court and get the money refunded. Not surprisingly, it didn’t work out the way he hoped.
In view of the fact I never heard anything from the IRS while I was a US citizen, its highly unlikely that I’ll be hearing anything from them now that I’m not a US citizen. Its been well over 5 years and nothing but crickets.
But I concede your point about being a hundred years too late to be considered the first to admit that the US system makes no sense. The IRS could actually use something like that for their motto, like: “One hundred years of confusing the hell out of people” or “Starting our second century of non-sense.”
Zla’od –
No problem then.
Hodgen on filing 8854
https://hodgen.com/filing-form-8854-late/
“One hundred years of confusing the hell out of people”
Makes perfect sense, for those who profit from the confusion. The confusion is the point.
re;
” “One hundred years of confusing the hell out of people” ”
and,
“Makes perfect sense, for those who profit from the confusion. The confusion is the point.”
Congress doesn’t care, except where it benefits their favourite political cronies, donors and lobbyists.
And continuing that confusion generates revenue for the IRS and the US tax accounting and law industrial complex, from those outside the US who are considering, or who try to comply in good faith – even when no tax is owed… Compliance isn’t really what they want from those ‘abroad’, when penalty revenues can be so very much higher than the utter zero of US tax they can assess in so many instances. They have no incentive to make it easier or clearer when confusion generates higher inadvertant penalty revenues in lieu of no taxes owed – even when they can’t collect it.
Inherent conflict of interest. Making it easier to understand and comply means less penalty revenue.
Stacks stacks of paper and fees and hours and days of LCUs (@Just Me’s ‘life credit units’) lost just to prove an obvious zero in my case.
Couldn’t face that for the rest of my days, or leaving the burden and mess to my Canadian-only family.
Renounce/relinquish and rejoice if and when you can. No point in waiting to see what new torment (complete with its own labyrinthine forms, plus draconian and confiscatory layer of penalty regime) will be enacted next.
The IRS doesn’t care that they’re moving ever faster down the road to create more and more people outside the US into renunciants, would-be renunciants, the ‘disappeared’ committed to flying under the radar (ex. those who are now choosing to keep mum about US parentage) and non-compliers. It is ironic because at first when I found out about USextraterritorial CBT and FBAR I thought given my income which was often only marginally large enough to be taxable in Canada, maybe I could just catch up and then keep complying – expecting that it would be as simple as my Canadian filings. But the more I tried to understand what the US wanted of me, the less I understood – except for the growing realization and horror that in trying to comply in good faith I was getting deep into a version of “Jarndyce and Jarndyce” territory https://en.wikipedia.org/wiki/Jarndyce_and_Jarndyce – even though a cursory glance at my income would demonstrate that it was impossible for me to owe the US any tax .
And now I and others who received a firsthand education in what ‘compliance’ truly means re US extraterritorial demands – are committed to helping people understand that complying could very well be an unhealthy option. That is the type of ‘education’ of taxpayers outside the US that the IRS is apparently deeply committed to fostering. Witness the creation, growth and health of IBS and other efforts growing here and in the EU and Australia – even nigh on 7 years later.
I think they thought and hoped that we’d fade away. And they knew that Congress and Senate didn’t give a rat’s patoot about us – except as we’re useful distractions as scapegoats.
Well, we’re still here aren’t we?
badger – “Compliance isn’t really what they want from those ‘abroad’, when penalty revenues can be so very much higher than the utter zero of US tax they can assess in so many instances.”
“But the more I tried to understand what the US wanted of me, the less I understood – except for the growing realization and horror that in trying to comply in good faith I was getting deep into a version of “Jarndyce and Jarndyce” territory.”
Absolutely. Well said. I haven’t lost money but I’ll never forgive them for getting me embroiled into trying to fathom the US tax system. The wasted hours…
I do believe the tide has turned though. I hazard a guess that Canadian-style relaxed due diligence will eventually become the norm, in Model 1 countries, and birthplace discrimination and forced US tax-residency will fall out of fashion with the Model 1 countries and therefore with many of their banks. I’m looking on the bright side, these days. 🙂
@plaxy, I cheer myself first and foremost that I severed the US cancer as cleanly as I could, and other than the birthplace on my birth certificate and Canadian passport (woe betide any Canadian FI who raises it with me), I put down that part of the burden and gained peace of mind. I can’t get back the preparation and legal fees I paid nor the lost time and the injury to my family wellbeing.
But, I can savour doing my small bit to help thwart US imperial extraterritorial incursions into Canada however I can. It is taking time, for ex. for the anti-FATCA lawsuit to be heard, but I take heart in the idea that an outcome in our favour will taste even sweeter ( “revenge is a dish best served cold”) though justice deferred is basically justice denied. It may not be a victory in the end, but at the very least perhaps the US and the Canadian FATCA-natics may have had some uncomfortable moments over the years since IBS was launched and with the various lawsuit/s. At the very least they were not able to do their dirty work completely hidden, unremarked and unopposed. Which is what at least the Canadian IGA enablers had hoped.
I’m not expecting an outcome in our favour – I think a tweak or two is more likely, letting the banks understand that the last thing the IRS is going to do is mark a Model 1 bank as “not FATCA compliant” for giving a resident French or Australian or German citizen a bank account.
I hope that if the witchhunt stops, CBT will once again fall off the list of things USCs need to worry about.
http://www.cpapracticeadvisor.com/news/12407291/making-sense-of-the-new-modernized-international-tax-regime
This is one of the more intelligent articles on the international provisions in the recent US tax reform.
The article recognises that the new corporate tax system is not really territorial:
It also notes that the transition tax is imposed on many taxpayers who will not benefit from the exemption for foreign income.
What it misses is that GILTI is a complete misnomer. GILTI essentially makes the assumption that all intangible income is US source, and classifies income as from intangibles if it is created through the use of leased assets or non-depreciable assets such as inventory. AND GILTI applies to individual shareholders at double the tax rate of corporate shareholders (or more)!
!
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