It’s the Subpart F Rules, Stupid

 

 

There is a very good discussion going on over at Brock regarding the “Transition Tax” and the unintended consequences that may be passed on to expats. Fortunately, this cross-posted comment by USCitizenAbroad demonstrates how we have moved from the complicated verbiage of statutes/IRS Code to something understandable. (!!!!!)

@Plaxy

First, there has never been ANY background discussion that suggests that a transition tax would apply to individual shareholders (whether in the US or abroad) of non-U.S. corporations.

Second, ALL of the discussion has been in the context of finding a way to impose taxation on the offshore trillions supposedly owed by the corporate shareholders of foreign corporations,

Third, notice that some of the discussion (for example in the two Morse articles) raises the question of how the tax should be designed (inside the income tax system, outside the tax system, subpart F, etc.).

What I think has happened is that, by making a subpart F inclusion the mechanism for taxing the “offshore trillions”, it has theoretically drawn individuals (and by extension Americans abroad) into harm’s way.

Because the subpart F rules do apply to the individual shareholders of Canadian Controlled Private Corporations (even though originally intended for corporations), and the mechanism to capture the “offshore trillions” is subpart F, individuals have been drawn in.

Had the mechanism for inclusion been something other than subpart F, I suspect that we would not even be having this discussion. But, what discussion? What is generating the discussion?

Interestingly, the ONLY discussion of the impact of this on individual Americans abroad comes from the tax compliance industry in Canada (because they are the only group considering individual Americans abroad) and probably tax people in other countries.

There is no final legislation and the rules are complex. So, what happens is that one tax person says: “These rules apply to Americans abroad” and the rest follow. They have few (if any) independent thoughts on this. It is very difficult to read and understand this proposed legislation. They read legislation literally. They don’t read contextually. They in effect “make up the law”. We have seen this happen time after time.

Now, what are individuals to do? It’s obvious that this tax was NEVER intended to apply to them. But, (I expect) the tax compliance industry will work hard to force people to pay up. What is clear is the tax compliance community will NOT (if they adopt the “party line”) tell people that the tax does not apply to them. They won’t be willing (and understandably so) take the risk. But, they don’t know any more about this than you or I.

So, what should be done? What should the response be?

At the present time there are still many unknowns. But, I really don’t see how people can pay a tax that

  1. was never intended for them
  2. will confiscate their retirement plans
  3. is in effect a retrospective tax – they are (possibly) going back in time and deeming income that was not taxable at the time to be taxable now.
  4. is not based on any “event” whatsoever – this is why it is pure confiscation. Even if it were 1 cent it would be pure confiscation because there is no event triggering a tax.
  5. (5) reaches directly into the tax base of Canada.

Since July the Government of Canada has been discussing this same pool of Canadian capital. This whole discussion is confusing theory, reality and practicality. This cannot and should not be paid.

My suggestion I guess is:

Get your tax preparer to reveal his/her position on this before work on the returns commences. If the preparer will not sign the returns without paying this tax – then find another preparer or do them yourself or don’t file at all. Obviously the pressure to renounce has become even more intense.

What you cannot due is let the tax compliance community turn your retirement savings over to the IRS based on a law that was never intended to apply to you.

Furthermore, I think that tax preparers have a moral obligation to make their position on this known in advance.

 

Seven Simple Points to be Made Re: Transition Tax and CFCs

 


 
This comment from the Isaac Brock Society makes basic points to be made with regard to the proposed “Transition Tax” in both the House and Senate Tax Reform Bills.
 
Every expat who knows there are private individuals who are incorporated in their country should be contacting relevant government representatives giving them the information that U.S. Tax Reform may impose a “transition tax.” As it is widely surmised that this is an unintended consequence, now is the time to bring it to the forefront and create awareness/resistance to this. We have appealed to the U.S. government to change the relevant sections (or give some clarification); if this does not occur, we cannot allow the compliance community to decide what the law is. In the past this HAS occurred with regard to the treatment of PFICs, applying the Exit Tax retroactively to people who renounced prior to 2008 and putting “minnows” into OVDP/OVDI. Time to stand up and say “NO!”
 
The following points would work for any country; just change the numbers in point 1 and “Canadian” to your country (generally) and the ministers’ names to yours.
 
1. There are approximately one million Canadian citizens who are resident in Canada and are also U.S. citizens (mostly Canada/U.S. dual citizens – with the U.S. citizenship conferred on them because of a U.S.
birthplace).

2. It’s safe to say that a significant number of these “dual citizens” are “small business owners”, who carry on business through Canadian Controlled Private Corporations.

3. It is possible and likely that many of these “small business” owners have (since 1986 or the date of incorporation) accumulated earnings.
These accumulated earnings operate as their “retirement pensions” ( a fact that has been widely discussed with Finance Minister Morneau and Prime Minister Trudeau as part of their discussions on Canadian tax reform).

4. The United States imposes taxation on individuals based ONLY on U.S.citizenship (even if the person lives in Canada). The United States is the only advanced country in the world to impose “citizenship-based taxation”. The United States is the ONLY country in the world that BOTH:
1. Confers citizenship based on birth in the country AND 2. imposes “worldwide taxation” based on citizenship.

5. Many of the Canadian Controlled Private Corporations owned by Canadians with dual citizenship are deemed under the Internal Revenue Code of the United States, to be “U.S. shareholders”, of what are called “controlled foreign corporations”. To repeat, from a U.S. perspective the Canadian shareholders of Canadian Controlled Private Corporations, may be considered to be the “U.S. shareholders” of “Controlled Foreign Corporations”.

6. The United States is in the middle of a process of amending the Internal Revenue Code. It appears that both the House and Senate versions of the bill, include a provision that would require the “U.S. shareholder” of a “controlled foreign corporation” to include directly in his/her personal income, a percentage of the total amount of the “retained earnings” of the “controlled foreign corporation” (which could well be a Canadian Controlled Private Corporation”). This percentage would be based on the amount of the retained earnings which have accumulated since 1986. See for example Sec. 14103 of
The Tax Cuts and Jobs Act

(See the section starting on page 375 with Sec. 14103 beginning on page391.)

7. Although it is not completely clear that this provision would apply to the Canadian shareholders of Canadian Controlled Private Corporations, the “literal reading of Sec. 14103 suggests that it may.

Certainly there have been (and this is where the danger lies) some tax professionals who are adamant that this would apply.

Conclusion:

It is extremely important that this danger be understood by all “stake holders” in Canada. This would include Finance Minister Morneau and members of the small business community in general.

Some discussion of this problem may be found here.

.

ADCS-ADSC & ADCT Letter to U.S. Congress

 

— In this press release we ask United States Congress to fix a problem in the present House/Senate tax bills that targets certain Canadian citizen/residents who own an incorporated business — and more broadly — to “stop imposing worldwide taxation on any Canadian resident”.

The press release is being sent in part to members of U.S. Congress and also to Canadian politicians who should be in the business of defending Canadian citizens from harm caused by a foreign state.

The focus of the press release is intentionally on “Canadians”. The word “American” is not mentioned. Our use in the text of the now-offensive term “U.S. person” (defined by the U.S. Internal Revenue Service) does not imply that U.S. person law applies to any Canadian resident or that any of these so-designated (by the U.S.) Canadians have ever consented to be U.S. persons.

*******
 

 
 
November 24, 2017
For Immediate Release

U.S. CONGRESS: DO NOT CONFISCATE OUR SMALL CANADIAN BUSINESSES AS PART OF YOUR TAX REFORM

Dear Congressperson,

On November 16, 2017 Rep George Holding, of the House Ways and Means Committee, in an exchange with Chairman Brady, urged that as part of tax reform that: The United States join the rest of the world by adopting “residence-based taxation”. This would END the U.S. current practice of imposing worldwide taxation on certain residents of other countries.
 
As U.S. law currently stands, many Canadian citizen/residents (who are deemed by the U.S. to be “U.S. Persons”) find themselves subject to U.S. taxation (ON THEIR CANADIAN INCOMES and CANADIAN ASSETS), even though they live in Canada and pay taxes to Canada.
The application of U.S. tax law into Canada – a principle enforced by FATCA – has profoundly negative consequences, some of which are intended and some of which are unintended.
 
This is a request that the wording of the United States “Tax Cuts and Job” bill be revised so as not to harm, even more, small Canadian businesses possibly included, we believe inadvertently, by your proposed tax reform legislation.
 
As your tax Senate and House tax reform bills are presently worded, Sec. 14103, for example in the Senate bill, might be interpreted to confiscate a significant percentage of the retained earnings of certain small “Canadian Controlled Private Corporations”. This is evidently part of broader legislation to implement “territorial taxation”, in order to enhance the competitiveness of publicly traded U.S. multinational corporations.
 
We believe that this section is intended to apply ONLY to the foreign subsidiaries of U.S. domestic corporations. However, a strict reading of the language of the bill suggests that this “transition tax” MIGHT also be paid by those who are deemed by your country to be “U.S. persons” living overseas who happen (as is common in Canada) to own an incorporated small business. The “minnows” swept up by your bill will then include small businesses such as a one-person incorporated medical doctor’s clinic, should the owner be designated by U.S. law to be a “U.S. person”.
 
We do not believe that this was your intention and ask that you fix the language of the bills accordingly. Surely you would agree that “territorial taxation” for U.S. multinational corporations does NOT mean that the United States should extend its taxable “territory” to Canadians who happen to own small Canadian Controlled Private Corporations!
 
As part of U.S. tax reform, we conclude by asking that the United States stop imposing worldwide taxation on any Canadian resident AND clarify that the “Tax Cuts and Jobs” Bill does NOT apply to Canadian residents who are shareholders of Canadian Controlled Private Corporations.
 
John Richardson
Carol Tapanila
Patricia Moon
Stephen Kish

 
On behalf of the
Alliance for the Defence of Canadian Sovereignty (www.adcs-adsc.ca ) Information@adcs-adsc.ca;
and
Alliance for the Defeat of Citizenship Taxation (www.citizenshiptaxation.ca)
 
Contact Mr. John Richardson at johnrichardson@citizenshipsolutions.ca
 
 

The Merry-Go-Round of “Unintended Consequences”

 

This provision is not designed to catch individuals (I think), and certainly not Americans abroad – they are collateral damage. it’s incredibly unfair.

A little more than 10 days ago, an article by a Canadian tax lawyer claimed the proposed House Bill contained two very startling changes that would affect #AmericansAbroad:

BAD NEWS FOR BUSINESS OWNERS
If your cross-border client owns a business, his tax position “may get substantially worse,” Reed says, noting two areas of concern:

a one-time 12% tax will be imposed on all income previously deferred from U.S. tax in Canadian (foreign) corporations; and
new complex rules make it difficult for U.S. citizens who own Canadian (foreign) corporations to defer active business income.
The 12% tax is part of the transition to a territorial corporate tax system.

“Although perhaps unintentional, since U.S. citizens will not benefit from a territorial model, the new rules impose a 12% tax on any cash that has been deferred since 1986,” says Reed.

He offers the example of a U.S. doctor who moved to Canada in 1987 and has since deferred income from personal tax in her medical corporation, and invested it — resulting in a potentially significant tax bill.

Deferring active business income

New punitive rules that apply to US citizens who own a business. Currently, most US citizens who own a Canadian corporation that is an active business don’t pay tax on the company’s profits until they take the money out. The House plan changes this. It imposes a new, very complicated, set of rules on US citizens that own the majority of a foreign corporation. The proposal would tax the US citizen owner personally on 50% of the entire income of the Canadian corporation that is above the amount set by an extremely complex formula. At best, this will make the compliance requirements for US citizens that own a business extremely complicated and expensive. At worst, this will cause double tax exposure for US citizens who own a Canadian business on 50% of the profits of that business.
 

This post was a response to the issues raised.

 

Today, another Canadian compliance professional made similar observations about the proposed Senate bill.

 

Kevyn Nightengale published an article on LinkedIn; excerpts below:

American? Own shares in a foreign corporation? Get ready for a pain in the wallet

Published on November 10, 2017
by Kevyn Nightengale

Accumulated deferred foreign income

One thing they will do is apply an immediate tax (well, sort of immediate – it’s to be paid over 8 years) to the retained earnings of those foreign subsidiaries. And there’s some logic to this as well. Those earnings have been tax-deferred until now. If they fell into the “exempt” system in future years, US multinationals will have effectively gamed the system by keeping them offshore long enough to completely escape tax.

One problem is that if you’re an American individual, and you own shares in a foreign corporation directly, this provision will create an immediate tax in your hands.

You won’t get a foreign tax credit for the corporate tax (like a US domestic corporate parent). You won’t get a special deduction (like a US domestic corporate parent). You just have to pay tax on the retained earnings.

It’s a double whammy if you live abroad

If you live in a country where it’s common to run a small business through a corporation (say, Canada), you already have enough double-tax issues to worry about (Subpart F, filing forms 5471, FINCEN 114, etc.). This new provision will probably lead to double taxation. And even if you can pay out dividends to limit that, it probably will create extra tax in your country. The US tax probably isn’t creditable in your country (in Canada, it isn’t).

Global intangible low-taxed income (“GILTI”)

…… The shareholder (yes, including a US citizen living abroad, in the same country as the company) has to include an amount in his income.

The amount is the company’s total income less a deemed return (10%) on tangible assets. This means that any type of income is caught. Companies that provide services are especially vulnerable, because they typically have only a small amount of tangible assets. Incorporated professionals are going to be hit hard. They’ll be taxed on their companies’ incomes, even if the company doesn’t distribute it to them. And that tax will apply at full tax rates, not qualified dividend rates.

Can this be avoided?

This provision is not designed to catch individuals (I think), and certainly not Americans abroad – they are collateral damage. it’s incredibly unfair.

*******
 
I find it puzzling that both gentlemen indicate these policies are not intended to include #AmericansAbroad, yet act as if they have no choice but to “enforce” this if it becomes U.S. law. Haven’t the “unintended” consequences of #FBAR caused enough grief for #AmericansAbroad? Why does everyone assume there is nothing that can be done to stop this from extending to expats? If the law is not meant to be applied that way, does not specifically indicate they are to be included, how can they claim they must do so because it is “U.S. law?” That is clearly not the correct position to take. And what will the result be if people are mad/scared enough to simply not deal with this U.S. situation any longer?

 

*******

John Richardson comments:

There are many who interpret the proposed changes, to include a provision that would lead to the confiscation of a significant portion of the retained earnings of small business corporations, owned by Americans abroad. I wrote the above referenced post and used the example of a U.S./Canada dual citizen living in Canada who owns a small business corporation. By the way, it is very common for Canadians to utilize small business corporations to carry on their businesses.

This specific provision is found in Sec. 4004 of the Proposed tax bill.
The way it would operate (after identifying those who own small Canadian Controlled Private Corporations in Canada) would be to:

1. Focus on the retained earnings of the corporation since 1986. Note that these earnings were either NOT subject to U.S. taxation at the time or were already included in the income of the shareholder via the subpart F provisions.

2. Impose a tax of either:

House Bill: 14% (cash) or 7% (non-cash)

Senate Bill: 10% (cash) or 5% (non-cash)

on the retained earnings by including those earnings in Subpart F income.

Understand that for many Canadians these small business corporations contain their retirement savings. So, the bottom line is the the United States proposed to literally confiscate these assets.

Understand also that Sec. 4004 is part of the section that creates the system of territorial taxation for U.S. corporations. The idea is that the “transition tax” is a way to repatriate the earnings which have not returned to the USA (obviously because of confiscatory taxation). After paying this “transition tax” those U.S. corporations will get the benefit of territorial taxation.

Understand also that U.S. individual shareholders of Canadian Controlled Private Corporations do NOT get the benefit of “territorial taxation”
but (if this is interpreted correctly) are still required to pay this.

What the USA, in it’s great wisdom is doing, is to:

1. Retroactively go back and deem income that was NOT taxable at the time to be taxable; and

2. Use the mechanism of subpart F inclusion (I am not going to dignify this by calling it a tax) to CONFISCATE the asset.

Understand also that this is one more of a long line of indignities inflicted on Americans abroad that includes:

– the virtual confiscation of Canadian pensions (via the Sec. 877A Exit Tax rules applied to some who renounce U.S. citizenship) that were earned in Canada while the individual was NOT living in the United States; and

– the application of the 3.8% Obamacare surtax to distributions of from Canadian RRSPs (the equivalent of U.S. IRAs) and excluding distributions from IRAs.

I suspect that this will be the “straw that breaks the camel’s back”.

And “The Band Played On ….””