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 ….””
