IRC Section 965 Transition Tax – Part 5

John-Richardson- Investigating the Transition Tax

Shades of ODVP

This is the fifth 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.

The purpose of this post is to argue that (as applied to those who do not live in the United States) the transition tax is very similar to the OVDP (“Offshore Voluntary Disclosure Programs”).

Reasons Why The U.S. Transition Tax as applied to “nonresidents” is similar to the “Offshore Voluntary Disclosure Program As Applied To “Nonresidents”. In both cases there are benefits to Homeland Americans and extreme detriments to “nonresidents”. These detriments amount to a punishment for living outside the United States and becoming a “tax resident” of another country.

Reason 1: Both the U.S. Transition Tax and the “Offshore Voluntary Disclosure Programs” were based on a payment of the percentage of assets and NOT on a “realization event”.

In the case of OVDP, the penalty was based on a percentage of the value of assets what were used to generate income.

In the case of the “transition tax”, a payment is demanded based on a percentage of the “retained earnings” of the company (which exist to earn income).

In neither case is the payment based on a specific “realization event”. In other words, most instances of taxation are levied on a purchase or a sale. In this cases of “OVDP” and the “transition tax”,  the payment is demanded based simply on the fact that the asset (pool of capital exists).

Both “OVDP” and the “transition tax” operate on the:

“Oh my God, we see capital assets. Turn a percentage of them over”, principle!

We are going to seize those assets!

For this reason, both the “transition tax” and OVDP are/were “wealth extractions” that operate more like “confiscations of capital” rather than taxation based on a “realization event“.

Reason 2: Both the “transition tax” and the OVDP programs are/were, when applied to “nonresidents”, the confiscation of wealth that actually belongs to another country.**

In both cases, the “programs” result in the confiscation of assets over which the “nonresident’s country of residence” has primary taxing jurisdiction. For example, Canada has primary taxing jurisdiction over Canadian Controlled Private Corporations. This principle is explicitly recognized in Section 5 of Article X of the Canada U.S. Tax Treaty which specifically prohibits the United States from imposing taxation on the “undistributed earnings” of Canadian corporations. The whole purpose of the “transition tax” is to impose U.S. taxation on the “undistributed earnings” of Canadian corporations.

As the tax treaty states:

5. Where a company is a resident of a Contracting State, the other Contracting State may not impose any tax on the dividends paid by the company, except insofar as such dividends are paid to a resident of that other State or insofar as the holding in respect of which the dividends are paid is effectively connected with a permanent establishment or a fixed base situated in that other State, nor subject the company’s undistributed profits to a tax, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State.

Reason 3: Both the “transition tax” and OVDP are programs that benefit Homeland Americans AND are incredibly destructive to “nonresidents” (Americans abroad)

For long term Americans abroad, most of their assets are located outside the United States would be considered (from a U.S. perspective) to be “foreign”. For Homeland Americans a much smaller percentage of their assets would likely be “foreign”. Under “OVDP” a higher percentage of the “assets” of Americans abroad would be subject to the penalty base.

Americans abroad would create corporations that are local to them, but “foreign” to the United States. Homeland Americans creating “non-U.S. corporations” really are creating corporations that are foreign to them. Americans abroad are creating corporations in countries where are “tax resident”. Homeland Americans, who use “foreign corporations” are creating corporations where they are NOT “tax resident”.

For long term Americans abroad, their “foreign assets” were almost certainly “after tax” assets accumulated in their country of residence. For Homeland Americans their “foreign assets” were more likely to have been used to avoid taxes.

Conclusion: Although Americans abroad were more likely to be innocent, they were likely to pay a higher price to participate in OVDP, than a Homeland American. As previously discussed, the “transition tax” is a benefit to Homeland Americans but an instrument of “pension confiscation” for Americans abroad. A Homeland American who creates a “local corporation” is NOT subject to any kind of “transition tax”. A “nonresident” who creates a “local corporation” (which is “foreign to the United States) is creating a corporation that is subject to the “transition tax”.

Reason 4: For Americans abroad both the “transition tax” and OVDP operate primarily as pension confiscations.

For many nonresidents, the retained earnings in their small corporations are considered to be their pensions. They represent a lifetime of work, savings and labor. Entrepreneurs do not typically have the “private pension plans” available to certain kinds of “salaried employees”.

In the same way that (for Americans abroad) the “OVDP” program confiscated “after tax paid” assets owned by Americans abroad, the “transition tax” is confiscating after tax paid capital that operates as a private pension plan.

Both the “transition tax” and “OVDP” confiscate assets that are regarded as the “pension plans” of their owners.

Reason 5: In both cases it is difficult to find competent professional advice concerning how the program/statute works and what the terms of the program/statute really are.

During the 2011 “OVDI” panic it was very difficult to find competent professional help that could help one understand, evaluate and estimate the costs of participation in the program.

During 2018 it is very difficult to find professionals that are competent to help you understand how the “transition tax” works and possible offsets.

Looking for help with “transition tax”? Good luck to you!

Reason 6: Both the “OVDP” programs and the “transition tax” come with very very significant compliance costs!

If you are able to find someone to assist you with “transition tax” compliance, it will come with very high professional fees. For the “transition tax” the issues include (but are not limited to):

  • how much income is subject to the “transition tax”?
  • of the included income, what is the ratio of “cash” to “fixed” assets?
  • what is the total tax owing?
  • how is this tax to be paid? By using tax credits from Canada (either personal or corporate)? By paying the tax without the advantage of “tax credits”?
  • does the installment option make sense?
  • etc.

If you were able to find someone to help you with “OVDP” compliance the professional fees could easily have been six figures.

Think of it: participants in the “OVDP” and “transition tax” programs are paying huge professional fees to commit financial suicide!

IRC Section 965 Transition Tax- Part 1

IRC Section 965 Transition Tax- Part 2

IRC Section 965 Transition Tax- Part 3

IRC Section 965 Transition Tax- Part 4

The Reality of U.S. Citizenship Abroad

My name is John Richardson. I am a Toronto based lawyer – member of the Bar of Ontario. This means that, any counselling session you have with me will be governed by the rules of “lawyer client” privilege. This means that:

“What’s said in my office, stays in my office.”

The U.S. imposes complex rules and life restrictions on its citizens wherever they live. These restrictions are becoming more and more difficult for those U.S. citizens who choose to live outside the United States.

FATCA is the mechanism to enforce those “complex rules and life restrictions” on Americans abroad. As a result, many U.S. citizens abroad are renouncing their U.S. citizenship. Although this is very sad. It is also the reality.


Subscribe to TaxConnections Blog

Enter your email address to subscribe to this blog and receive notifications of new posts by email.