This is the third in my series of posts about the Sec. 965 Transition Tax and whether/how it applies to the small business corporations owned by tax paying 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.
Those who fail to learn from history are doomed to repeat it
Immediately prior to the passing of President Obama’s “Affordable Care Act” (which was subsequently ruled to be constitutional BECAUSE it was a “tax”), legislators were faced with a comprehensive, complex and incomprehensible piece of legislation. Very few members of Congress understood the details and impact of what they were voting for.
Nancy Pelosi secured her in place of history by suggesting that, “We really need to pass the law so that you can see what’s in it!” Ms. Pelosi meant (I think) that it’s one thing to know what a law says. It’s quite another to know how it actually impacts people.
Notwithstanding the April 15, 2018 deadline for the first “transition tax” payment, very few “tax professionals” understand what the Internal Revenue Code Sec. 965 “transition tax” says, (let alone what it actually might mean – assuming it applies).
What the application of the “transition tax” might actually mean in the life of an individual owner of a Canadian Controlled Private – The “law?” of unintended consequences – surely this wasn’t intended to apply to the residents of other countries?
Does the “intent” of the law matter? Orrin Hatch seems to think so. (Senator Orrin Hatch was Chairman of the Senate Finance Committee in 2015 when the Committee focused on the “Tax Reform Project”. The “Alliance For the Defence of Canadian Sovereignty” submission to the Committee is discussed here.
There was NO evidence that the Sec. 965 “transition tax” was intended to apply to the small business corporations owned by Americans abroad. The legislative history (such as there is) suggest no awareness that this “tax” would apply to the “tax residents” of other countries. Yet, the “tax professionals” seem unwilling to consider this question.
Speaking of the “tax professionals”
The role of the “tax professionals” in the making and marketing of the “transition tax”
It is inconceivable that any “individual” could read (without the interpretative aid of a “tax professional”) and conclude that the Sec. 965 “transition tax” applied to them. As of the date of this post, there is no “notice” from the IRS explaining how the law would apply to individuals (let alone Americans abroad). But, how “tax professionals” interpret the legislation – in effect – creates the law. The “tax compliance” industry has been taking a very “literal approach” to the language and interpreted the law to apply to individual Americans abroad. The “making and marketing” of the “transition tax” is very much like the “making and marketing” of the PFIC rules. The marketing of the “transition tax” is very much like the “making and marketing of OVDP AKA “The FBAR Fundraiser”.
Residents of countries outside the United States are being informed that laws apply to them that they cannot understand and that they couldn’t even imagine could apply. Tax professionals seem reluctant to consider that there may be “treaty provisions” that (notwithstanding the “savings clause“) could be used to protect Americans abroad in Canada. But, I digress …
The role of the media in the making and marketing of the Sec. 965 “transition tax”
The media has been complicit in the “making and marketing”of the “transition tax”. As Patricia Moon, writing at the Isaac Brock Society explains:
Another day, another set of articles and comments where the Transition Tax & GILTI are being stuffed down the throats of expatriates who have their own small corporations. The proliferation of articles on this issue, all proclaiming the U.S. can now inflict a deeper cut into the retirement savings of non-residents, is infuriating. The first two articles at least expressed the idea that these provisions might affect non-resident U.S. taxpayers.
The new “class warfare”
As governments become more and more confiscatory, the new “class warfare” will increasingly be between those who can retire because they have “retirement pensions” and those who cannot retire because they do not have “retirement pensions”. In an age where people are living longer coupled with an increase in the percentage of “single people”, pensions matter hugely. Those who believe they can live on their Canada Pension Plan will be disappointed. Pensions (as demonstrated by the history of pensions in Rhode Island) have become a huge social and public policy issue.
The February 27, 2018 Canada AKA “Morneau” budget included a specific recognition of how Canadian Controlled Private Corporations were used to generate “investment income”. Naturally, the Minister Morneau included specific provisions to end the use of “CCPCs” to create private pensions plans. (You would think he would have encouraged this. But, such is the strange logic of governments.)
How U.S. tax laws target the pension and retirement plans earned by residents of other countries
The United States does NOT enact with laws with the intention of targeting the pensions earned by residents of other countries. But, the United States does impose direction taxation on the residents of other countries. By enacting laws that affect the residents of other countries, the United States uses the Internal Revenue Code to “export” U.S. cultural values on the residents of other countries. This is particularly true when one considers how the Internal Revenue Act impacts “retirement planning”. To put it simply, those who reside outside the United States, who ARE “subject” to the Internal Revenue, do NOT have the same “financial planning opportunities” as those who are NOT subject to the Internal Revenue Code.
The Australian “Superannuation” is an excellent example of a social and government initiative to “solve the pension problem”. (Those Australian residents with U.S. citizenship have a constant worry about how the Internal Revenue Code applies to their “Australian Superannuations”.)
The U.S. S. 877A “Expatriation Taxes” have a specific provision targeting those with “deferred compensation” AKA “private pension” plans. Americans abroad, who have “deferred compensation plans” outside the United States will find that they are subjected to particularly confiscatory “taxation” if they renounce U.S. citizenship. They are required to include the “commuted value” of the plan in their incomes for a “one off tax”. (For an example of how the S. 877A “Exit Tax” rules target non-U.S. pension plans, see here.) Significantly those with U.S. based “deferred compensation plans” are NOT required to include the value of comparable plans in their income.
Incredibly the 3.8% Obamacare surtax applies to distributions from Canadian RRSPs and RRIFs but does NOT apply to distributions from U.S. 401K plans. This is one more example of the United States targeting the retirement plans of the residents of other countries.
Furthermore, I would argue (see below) the Sec. 965 “transition tax” is a U.S. tax on the pensions and retirements plans of residents of other countries.
It’s about the pensions stupid! About the Canadian Controlled Private Corporation as a pension
In previous posts I have reinforced the point that many Canadians use Canadian Controlled Private Corporations operate as “private pension plans”. The more that Canadian Controlled Private Corporations are used as “private pension plans”, the more likely the assets will consist of “cash and liquid assets”. Significantly, the Sec. 965 Transition Tax imposes a higher rate of confiscation taxation on the “cash and liquid assets” of CFCs than on “fixed assets”. (The rate of tax imposed on “cash and liquid” assets is almost twice the rate imposed on “cash and liquid assets”.)
Food for thought – distinguishing the literal language from what this actually means in the lives of people affected
The more that a Canadian Controlled Private Corporation functions as a “private pension plan” the more punitively the Sec. 965 “Transition Tax” would impose taxation on the shareholder. The more the assets of the corporation are in “fixed assets” (for example land), the less the rate of taxation. (For individuals in the top tax rate, it’s a rate of 17.54% for “cash and liquid assets” and approximately 9% for “fixed assets”).
The way that this affects a life depends on (1) what the corporation really is (active business or “pension” plan and (2) the age of the individual (do they have enough years to recoup the “transition tax hit”?
Imagine the following two scenarios which illustrate the significance of “age” and “where” the retained earnings have been invested
Scenario 1: A Canadian resident is 65 years old. He has been carrying on his business through a Canadian Controlled Private Corporation since 1986. He has saved assiduously and has accumulated (through frugal living) three million dollars which his retirement pension. Because it his his “retirement pension”, the three million dollars is invested in cash/liquid assets. Under the “transition tax” rules he would be “taxed” at the highest rate. He is now required to turn a significant portion of this over to the U.S. Government. At the age of 65 he has no way of making this up. It’s “bye bye” retirement!
This is made even more offensive and unreasonable because the Sec. 965 “transition tax” is a “retroactive tax” on income that was NOT subject to U.S. taxation at the time that it was earned! And hey, the idea is that is to be applied to people who don’t even live in the United States!
Scenario 2: A Canadian resident is 45 years old. He has had the Canadian Controlled Private Corporation for only 5 years. Because he has had the corporation for only 5 years, he has only one million in retained earnings. Most of that one million is invested in an office building that he uses to run his law practice. Because the one million is invested in a fixed asset, the “transition tax” is payable at the lower rate. Think of it! He pays the lower rate because of the way in which the one million dollars has been invested. But, the real point is that the 45 year old lawyer is young enough to “make up” the loss.
Finally: This is made even more offensive and unreasonable because the Sec. 965 “transition tax” is a “retroactive tax” on income that was NOT subject to U.S. taxation at the time that it was earned! And hey, the idea is that is to be applied to people who don’t even live in the United States!
In event, payment of this tax may be simply impossible. Where would people get the money?
To put it simply:
“The Sec. 965 transition tax operates most punitively in relation to the confiscation of pensions!”
If you are a “tax paying” resident of another country, you could be forgiven for thinking that:
“The United States hates you for (and wants) your pensions!”
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