Exporting U.S. taxes, forms and penalties to the residents of other countries
"The Little Red Transition Tax Book" – Everything you need to know about the 965bmandatory repatriation tax but didn't know to ask. A horrific abuse of #Americansabroad in a @citizenshiptax and #FATCA world! https://t.co/j7v1Asreek— U.S. Transition Tax – Subpart F and #GILTI (@USTransitionTax) June 26, 2023
In the Moore appeal, the Supreme Court of the United States is charged with the task of determining whether “realization” is a necessary condition, for an “accession to wealth”, to qualify as “income” under the 16th Amendment. This broad question arises in the context of the Moores, who as “U.S. Shareholders” of a CFC, were subjected to the MRT which facilitated the double taxation of the Moores. The Moores, who reside in the United States, certainly have not and have no expectation of receiving a distribution from the India corporation. As problematic as the MRT was for the Moores, the MRT was far more devastating for Americans abroad, who were operating businesses that although “foreign to the United States”, were “local” to them. For the Moores their investment in the CFC represented an investment in a corporation that was “foreign” to both the Moores and the United States. Americans abroad were shareholders in CFCs (unlike the Moores and other resident Americans) that were “local” to them but foreign to the United States. In addition, for Americans abroad the CFC typically represents a pension/retirement planning vehicle. How can it be that the MRT could apply to individuals who live in other countries and are shareholders of corporations created in those countries? The answer is of course the extra-territorial application of the U.S. tax system to residents of other countries who happen to be U.S. citizens. In fact, the use of Canadian Controlled Private Corporations by dual US/Canada citizens living in Canada, demonstrates that it is possible for a U.S. citizen in Canada to be a shareholder in a Canadian corporation that would not qualify as CFCs if owned by U.S. residents.
The key takeaway is that the U.S. tax system, because of the extra-territorial tax regime (citizenship-based taxation) has a profoundly negative effect on individuals who are residents of other countries! U.S. tax law applies NOT only to U.S. residents but to residents of other countries who cannot demonstrate they are nonresident aliens. Therefore, a decision that the 16th Amendment does NOT require “realization” means that the U.S. will export the taxation of “unrealized income” to residents of other countries. The U.S. would tax the “unrealized income” of residents of other countries even when those other countries did not recognize the unrealized income as a taxable event!
In some circumstances the taxation of unrealized income would lead to double taxation. In other circumstances the taxation of unrealized income would frustrate the objectives of the tax policy of the other country. In many circumstances the taxation of “unrealized income” allows the United States to tax the wealth of other nations. It’s important to recognize that when the Supreme Court rules in the Moore appeal, it will also be deciding whether the U.S. can export the taxation of “unrealized income” to other countries! This has huge implications for both the residents and tax sovereignty of other countries.
Some EXISTING examples
1. Exporting unrealized income and double taxation:
Example (i): Imagine a U.S. citizen living in Canada has a stock portfolio of Canadian stocks in a Canadian brokerage account. If the U.S. taxes unrealized gains and Canada taxes only realized gains:
The individual would first pay taxes to the United States based on the unrealized gains and then pay taxes to Canada based on the realized gains. Note that because the income is sourced to Canada:
– the individual could NOT use U.S. tax paid as a foreign tax credit to offset the Canadian taxes owing (facilitating double taxation); and
– the U.S. would be taking a preemptive tax strike (exploiting the fact of no realization event in Canada) by taxing Canadian source income prior to a realization event in Canada. By creating an unrealized gain in the U.S., before the realization of gain in Canada, the U.S. would be effectively resourcing Canadian source income to the United States and syphoning capital from Canada to the United States. This is a clear violation of Canada’s tax sovereignty.
Example (ii): Imagine a dual U.S./Canada citizen living in Canada with a large pension which accrued in Canada and based only on employment in Canada. Imagine that the individual wishes to renounce U.S. citizenship. The U.S. 877A Expatriation Tax rules would (1) create a deemed distribution of the full Canadian pension for U.S. tax purposes without a corresponding distribution in Canada. The result is that the U.S. Treasury would simply confiscate a significant percentage of the retirement pension owned by a Canadian resident. Obviously the individual would be required to pay Canadian tax on future actual distributions in Canada.
Neither the Canada/US tax treaty nor the U.S. Model Tax Treaty would prevent these outcomes caused by “unrealized income” and (because of the “saving clause“) actually facilitates this outcome.
2. Exporting unrealized income and frustrating the tax policies of other nations:
Tax codes are about far more than revenue raising. They are also expressions of how countries incentivize retirement and other financial planning. In a world where fewer and fewer individuals have pension plans, it is more and more important for individuals to take charge of their financial futures.
Example (iii): Canadian residents who are Canada/US dual citizens who invest in mutual funds
Individuals around the world invest in mutual funds as a means to achieve their retirement and financial planning objectives. The U.S. imposes shockingly punitive taxation on non-U.S. mutual funds. This is called the PFIC regime. In essence, the PFIC regime imposes (in addition to the normal taxation of distributions and capital gains) via 26 U.S. Code § 1291 – Interest on tax deferral. The theory is that the individual receiving the distribution is subjected to a U.S. tax based on (1) pretending that the individual actually received income when the individual may not have received income coupled (2) with the imposition of interest compounded daily on the income that may not have been actually received. The “Interest on (pretend) tax deferral” is a shocking example of the creation of “fake” income in years when no income was realized. In short, the PFIC regime contemplates the realization of income when income may not have actually been received.
Example (iv): Canadian residents who are Canada/US dual citizens who create Canadian Controlled Private Corporations
The effects of the 965 transition AKA MRT on Canada/U.S. dual citizens resident in Canada have been demonstrated.
The key point is that the U.S. taxation of “unrealized income” does violence to the tax policies of other nations. In this example, the U.S. (once again) uses “unrealized income” as a way to frustrate Canada’s tax policy to facilitate retirement and financial planning.
A Proposed example – Warren Wealth Tax
3. Exporting The “Elizabeth Warren Wealth Tax” via the extra-territorial tax regime:
Wealth taxes are part of the discussion about future U.S. tax policy. As long as the U.S. extra-territorial tax regime exists, the adoption of a “wealth tax” as an “income tax” would potentially export a U.S. wealth tax to other countries. The proposed Warren wealth tax assumes that U.S. citizens, regardless of where they live in the world, would be subject to her proposed “wealth tax”. In fact, the enforcement of her “wealth tax” relies on and assumes the continued existence of the U.S. extra-territorial tax regime.
The Evolution of Taxation From Taxation Of Income (Sharing Of Income) To Taxation On Wealth (Taking Of Assets)
The proposed wealth tax is a tax, that is NOT based on a realization of income, but rather based on the ownership of assets. These are taxes which few resident Americans have encountered. On the other hand, taxes that are NOT based on the realization of income, are part of the daily life of Americans abroad. All resident Americans need do, to see what is in store for them, is to observe the separate and more punitive – extraterritorial tax system – imposed on Americans abroad. The tax system imposed on Americans abroad is becoming a system based more and more on non-income realization events. In this regard, Senator Warren’s proposal joins the club of other recent non-realization taxes which include: 877A Exit Tax, Transition Tax, GILTI, PFIC (and for Americans abroad phantom capital gains). Notice that this list of “fake income” taxes (for now) applies primarily to the tax residents of other countries who hold US citizenship.
A more detailed written discussion of the impact of the Warren Wealth Tax on residents of other countries is here:
A podcast featuring a discussion with U.S. tax lawyer Virginia La Torre Jeker is here:
Conclusion: The U.S. taxation of “unrealized income”, coupled with exporting U.S. taxation through the U.S. extra-territorial tax regime to residents of other countries, has implications that extend far beyond U.S. domestic tax policy. The effects of U.S. taxation of unrealized income on the residents of other countries is already clear. Therefore, the meaning of income in the 16th Amendment should be understood to include a realization event. A requirement that a “realization event” is necessary for income would:
1. Make the effects of exporting U.S. taxation less devastating to residents of other countries; and
2. Provide the taxpayer (because of the income realization) the money required to pay the tax.
Interested in Moore (pun intended) about the § 965 transition tax?
Have a question? Contact John Richardson, Citizenship Solutions, Canada
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