Senate Committee on Finance
Attn. Editorial and Document Section
Dirksen Senate Office Bldg.
Washington, DC 20510-6200
Dear Chairman Hatch, Ranking Member Wyden, and all Members of the Committee:
Part A – Introduction
I am based in Toronto, Canada and work with U.S. citizens living outside the United States who are required to comply with the tax laws of both the United States AND their country of residence. U.S. citizens living in Canada (the majority of who are dual Canada U.S. citizens) are required to comply with the tax laws of both Canada and the United States. Dual citizens in general and “U.S./Canada dual citizens in particular, live in a world where compliance with U.S. tax laws is somewhere “between difficult and impossible”. The difficulty is first because of the potential for double taxation and second because the U.S. Internal Revenue Code imposes far more punitive taxation on U.S. citizens living outside the United States than it does on U.S. citizens living inside the United States.
Part B – Re: The 2015 Senate Finance Committee Report on Tax Reform
In 2015 large numbers of Americans abroad made submissions to the Senate Finance Committee regarding U.S. “citizenship-based taxation” and FATCA. You will find the submissions collected here:
The largest numberof submissions are from individuals who are Americans abroad. The Senate Finance Committee Report was released in July of 2015. The report is here:
There was only one reference to the concerns of Americans abroad. This reference was on pages 80 – 81. Specifically the report included:
- Overseas Americans According to working group submissions, there are currently 7.6 million American citizens living outside of the United States. Of the 347 submissions made to the international working group, nearly three-quarters dealt with the international taxation of individuals, mainly focusing on citizenship-based taxation, the Foreign Account Tax Compliance Act (FATCA), and the Report of Foreign Bank and Financial Accounts (FBAR). While the co-chairs were not able to produce a comprehensive plan to overhaul the taxation of individual Americans living overseas within the time-constraints placed on the working group, the co-chairs urge the Chairman and Ranking Member to carefully consider the concerns articulated in the submissions moving forward.
I am sorry to observe that the “concerns articulated in the submissions” of Americans abroad have been neither heard nor considered. At the risk of stating the obvious, most Americans abroad are “tax residents” of other countries and are therefore subject to taxation in those other countries. In addition, many of these Americans abroad are in fact citizens of the countries where they reside. They cannot: (1) live in other countries (2) be subject to taxation in those other countries and (3) be expected to be compliant with the Internal Revenue Code of the United States. Double taxation is only one part of the problem. The larger problem is that their non-U.S. retirement assets and pension plans are subject to punitive taxation by the United States. These problems cannot be alleviated by the use of the Foreign Earned Income Exclusion, foreign tax credits, or a combination of the two. See for example:
Part C – Senate Finance Committee Hearings about the “Tax Cuts and Jobs Act” – April 24, 2018
On April 24, 2018, the Senate Finance Committee held hearings which were designed to explore preliminary experiences with the new “Tax Cuts and Jobs Act”.
There hearings featured NO discussion of how the Tax Cuts and Jobs Act impacts Americans Abroad. Furthermore, the hearings included no discussion of the Section 965 “Repatriation/Transition” tax which (1) when applied to Homeland Americans is a “sweet deal” but (2) when applied to Americans abroad has the potential to effectively confiscate their “retirement savings”.
Part D – Defining the problem – The “transition tax” found in Internal Revenue Code Sec. 965 will destroy many Americans abroad
The purpose of this letter is to alert you to the disastrous impact that Section 965 of the Internal Revenue Code has on U.S. citizens with small business corporations (which qualify as “Controlled Foreign Corporations” under the Internal Revenue Code). It is common for many residents of non-U.S. countries to use LOCAL corporations to carry on their small businesses. In Canada, small business corporations are used both as (1) a way to carry on business and (2) a vehicle to create private pension plans. Note that these “corporations” are NOT foreign to the individual. On the contrary, they are “local” to the individual, but “foreign” to the United States. Unfortunately, the tax compliance industry is interpreting Internal Revenue Code 965 to apply to – Canadian Controlled Private Corporations – which really are the equivalent of small business corporations in the United States. As a result, Many Canadian/U.S. dual citizens must now choose between compliance with U.S. tax laws (which will erode a large part of the undistributed earnings in their corporations) and retaining their retirement savings.
Part E – The Contextual Background – Why a “transition tax” at all?
It’s perfectly clear that the purpose of the tax was to force U.S. multinationals to “repatriate earnings” which have not been subject to U.S. taxation in the past. To a large extent, it was a “trade off” for reducing the U.S. corporate tax rate from 35% to 21%.
To understand the context, see the following testimony of Apple CEO Tim Cook before a Levin Subcommittee.
It’s clear that the target of the law was U.S. multi-nationals and not individual Canadian residents with dual Canada/U.S. citizenship.
Part F – What Internal Revenue Code Sec. 965 Requires
Section 965 prescribes what I will refer to as the “transition tax”. In general, the “transition tax” imposes a “one time” tax on the “undistributed earnings” of certain Canadian (and other foreign) corporations. The tax is on undistributed earnings going back to 1986.
Part G – Re: The 2017 Tax Cuts and Jobs Act and the “taxation of Americans abroad”.
On December 22, 2017 President Trump signed the “Tax Cuts and Jobs Act” into law. The “Tax Cuts And Jobs Act” included a massive overhaul of the U.S. International Tax system as it affects U.S. corporations. There were no corresponding changes for individual Americans abroad. In fact, the “Tax Cuts and Jobs Act” has made things considerably worse. Specifically the “Transition/Repatriation tax” found in IRC Sec. 965 and the GILTI regime found in IRC Sec. 951A has made the situation for many Americans abroad impossible to continue.
The “Transition/Repatriation Tax” and “GILTI” were enacted without any awareness of how they might impact individuals who were (1) United States shareholders living outside the United States and (2) were also subject to the tax systems of other countries.
As you are probably aware, the Repatriation Tax and GILTI Tax regimes which were intended for corporate multinationals like Google and Apple have and will continue to have a devastating impact on a large and unintended group: Americans living abroad who are individual U.S. Shareholders of CFCs (herein “Americans Abroad”).
The following 7 points, which are based on a comment to an article published by the Financial Times of London, describe the impact of the “transition tax” on Canada/U.S. dual citizens who have Canadian Controlled Private Corporations:
Interesting article that demonstrates the impact of the U.S. tax policy of (1) exporting the Internal Revenue Code to other countries and (2) using the Internal Revenue Code to impose direct taxation on the “tax residents” of those other countries.
Some thoughts on this:
- Different countries have different “cultures” of financial planning and carrying on businesses. The U.S. tax culture is such that an individual carrying on a business through a corporation is considered to be a “presumptive tax cheat”. This is NOT so in other countries. For example, in Canada (and other countries), it is normal for people to use small business corporations to both carry on business and create private pension plans. So, the first point that must be understood is that (if this tax applies) it is in effect a “tax” (actually it’s confiscation) of private pension plans!!! That’s what it actually is. The suggestion in one of the comments that these corporations were created to somehow avoid “self-employment” tax (although possibly true in countries that don’t have totalization agreements) is generally incorrect. I suspect that the largest number of people affected by this are in Canada and the U.K. which are countries which do have “totalization agreements”.
- None of the people interviewed, made the point (or at least it was not reported) that this “tax” as applied to individuals is actually higher than the “tax” as applied to corporations. In the case of individuals the tax would be about 17.5% and not the 15.5% for corporations. (And individuals do not get the benefit of a transition to “territorial taxation”.)
- As Mr. Bruce notes, people will not easily be able to pay this. There is no realization event whatsoever. (It’s just: “Hey, we see there is some money there, let’s take it.) Because there is no realization event, this should be viewed as an “asset confiscation” and not as a “tax”.
- Understand that this is a pool of capital that was NEVER subject to U.S. taxation in the past. Therefore, if this is a tax at all, it should be viewed as a “retroactive tax”.
- Under general principles of law, common sense and morality (does any of this matter?) the retained earnings of non-U.S. corporations are first subject to taxation by the country of incorporation. The U.S. “transition tax” is the creation of a “fictitious taxable event” which results in a pre-emptive “tax strike” against the tax base of other countries. If this is allowed under tax treaties, it’s only because when the treaties were signed, nobody could have imagined anything this outrageous.
- It is obvious that this was NEVER INTENDED TO APPLY TO Americans abroad. Furthermore, no individual would even imagine that this could apply to them without “Education provided by the tax compliance industry”. Those in the industry should figure out how to argue that this was never intended to apply to Americans abroad, that there is no suggestion from the IRS that this applies to Americans abroad, that there is no legislative history suggesting that this applies to Americans abroad, and that this should not be applied to Americans abroad.
- Finally, the title of this article refers to “Americans abroad”. This is a gross misstatement of the reality. The problem is that these (so called) “Americans abroad” are primarily the citizens and “tax residents” of other countries – that just happen to have been born in the United States. They have no connection to the USA. Are these citizen/residents of other countries (many who don’t even identify as Americans) expected to simply “turn over” their retirement plans to the IRS???? Come on!
Some of these thoughts are explored in an earlier post: “U.S. Tax Reform and the “nonresident corporation owner”: Does the Section 965 “transition tax apply”?
Part H – About the problem of “double taxation”
To this I would add that, because Canadian residents are also subject to taxation in Canada, the Section 965 Transition Tax will certainly result in double taxation. The reason is that:
First, the transition tax is paid by the individual to the United States out of the undistributed earnings of the corporation.
Second, when the undistributed income is distributed Canada will impose a second tax on that same income.
Third, because of timing mismatches, there is no possibility of offsetting the Canadian tax owed by the U.S. tax paid.
Bottom Line: This is clear double taxation.
Part I – The Canada U.S. Tax Treaty and (1) double taxation and (2) U.S. taxation of the “undistributed earnings” of Canadian Corporations
U.S. taxation of the “undistributed earnings” of Canadian Corporations:
Paragraph 5 of Article X of the Canada U.S. Tax treaty reads as follows:
- 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.
By its plain terms the treaty appears to prohibit the United States imposing a tax on the undistributed earnings of a Canadian company.
Article XIV – Double Taxation
Article XIV makes it clear that the spirit of the treaty is to avoid “double taxation”. By creating a “fictitious taxable event”, the United States is creating an event to impose taxation before the Government of Canada imposes taxation according to their rules (which are based on an actual distribution and not a deemed distribution).
It seems reasonable to conclude that the Sec. 965 Transition Tax violates at least the spirit of the tax treaty.
Part J – U.S. Tax Treaties and the Tax Cuts and Jobs Act
The Sec. 965 transition tax is arguably only one part of the Tax Cuts and Jobs Act that may not respect U.S. tax treaties. As argued by H. David Rosenbloom:
“If the policies at work are clear, it must also be said that the international provisions have a distinctly isolationist flavor. They take no account of the larger world, where countries other than the U.S. exist and have their own ideas about taxation. They make no accommodation to the U.S. network of tax treaties, which the international provisions appear to violate in several respects. In fact, the word “treaties” cannot be found in these provisions at all. …
“The underlying problem is that the international provisions have been crafted on the unstated assumption that the U.S. is the only country whose tax policies matter. That is unfortunate not simply because it is untrue but because it holds the potential for serious harm to U.S. interests. It is a shame to see the country fritter away a position of world leadership in a field as important as international taxation – a field that has gained immeasurably in international recognition as a result of BEPS and other developments in the OECD, the European Union, and at the UN. The fact that the U.S. Congress pretended for years that the BEPS project did not exist is emblematic of the attitude that is now manifest in the new international provisions. Our companies are likely to pay a price for the decline in U.S. leadership but, make no mistake, it will ultimately have negative influence in many corners of our national life.”
Part K – How could this unintended consequence have occurred?
On a conceptual level, it seems pretty clear to me that Americans Abroad were an unintended target of these new laws. Otherwise, how could it be explained that: (i) An individual American abroad pays a Repatriation tax higher than Google and Apple? or (ii) these multinationals pay GILTI tax of 21% while an individual pays tax of 37%? or (iii) these corporate giants enjoy tax credits and deductions under the GILTI regime which an individual does not, or (iv) an individual’s small-business counterpart based in the United States, carrying on business through a U.S. corporation, would never ever be subject to such draconian taxes or complicated compliance or (v) those individuals living INSIDE the United States carrying on business through a CFC would NOT be impacted by the “Transition/Repatriation” in the same devastating way that an individual living outside the United States would be.
On a practical level, while Google and Apple had and continue to have access to dedicated teams of expert tax specialists working to minimize their taxes, individual Canadian residents do not have access to the kind of sophisticated accounting and legal advice that is necessary for complying with these sophisticated laws.
Part L – Unintended consequences, real people with real lives and real suffering
But enough of the theory, the lives and retirements of individuals are being destroyed by the unintended consequences of the Sec. 965 “transition tax”.
For example, meet Suzanne and Ted Herman of Vancouver, British Columbia:
Begin with the video here:
Here is @suzanneherman1 on CBC “The National” talking about the transition tax
The Herman’s are only the “tip of the iceberg”, and one of the very few families who have been willing to “go public” to explain this problem.
Part M – It’s all a mistake – please fix it!
On behalf of the many individual U.S. citizens living outside the United States, I ask you to exempt them from these draconian taxes. While I may not have been the target of these taxes, they are financially disastrous to them.
Part N – A proposed solution
There is a simple balanced solution to solve this problem: an American living abroad should be exempt from the Repatriation and GILTI Tax regimes for any given year so long as: (1) the American meets the conditions set forth under IRC Section 911, and (2) that person is an individual U.S. Shareholder.
I strongly request that the Congress act to correct this most painful problem. I thank you for considering my statement.
Barrister and Solicitor
55 Bloor St. W.