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U.S. Tax Reform – Deemed Repatriation Tax and Individual Shareholders of Canadian Corporations

On December 22, 2017 President Trump signed into law, “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” (Public Law 115-97). The legislation had previously been introduced and is informally known as the Tax Cuts and Jobs Act (H.R.1).  This legislation is the most significant U.S. tax reform since President Reagan’s Tax Reform Act of 1986 (Public Law 99-514).

A number of provisions deal with International taxation and provide for a transition to an exemption tax system. On a go forward basis, active business income earned in certain foreign corporations will no longer be subject to U.S. taxation when repatriated back to the United States.  The media, however, had promoted these changes as impacting U.S. multi-national enterprises (MNEs).  For some provisions this description is accurate.  For other provisions, not quite so.

Transitional Tax

The legislation provides for a one time transitional tax and subjects all undistributed post-1986 earnings and profits (E&P) to a deemed repatriation.  This deemed repatriation will impact all United States shareholders of “deferred foreign income corporations”.  A deferred foreign income corporation is a foreign (non-U.S.) corporation that (i) has at least one “United States shareholder (see below)”; (ii) has post-1986 E&P (other than income effectively connected with a U.S. trade or business, or that has already borne U.S. tax – remember it is untaxed earnings that is the target); (iii) be a controlled foreign corporation (CFC) or have at least one U.S. domestic corporation as a U.S. shareholder; and (iv) not be a Passive Foreign Investment Company (PFIC).

A “United States shareholder” is defined as a U.S. person (which includes a U.S. citizen or lawful permanent resident) who owns, directly or indirectly, 10% or more of the voting stock of all stock of the corporation entitled to vote.  A controlled foreign corporation is a non-U.S. corporation where United States shareholders, either by themselves or in aggregate, control more than 50% of the votes of all stock of the company entitled to vote or own stock having more than 50% of the value of the corporation.

As such, for example, a U.S. citizen who is a Canadian resident and who owns 100% of a Canadian corporation will be caught under these rules.

Calculation of Transitional Tax and Payment Options

The deemed repatriation creates additional subpart F income.  Historically subpart F income included passive investment income (and capital gains) as well as personal service contract income.  Subpart F income is taxed as ordinary income, not as a qualified dividend. As such the income will be taxed at the taxpayer’s marginal tax rates. The amount that will be included in income, in 2017, is the greater of post-1986 E&P as of November 2nd and December 31st.  There are, however, special tax rates that will apply.  The rules act to impose an effective tax rate of 15.5% on E&P that is represented by cash and near cash accounts (including net A/R and A/P) and an effective tax rate of 8% on the remainder.  The actual effective rate, however, will be a function of the individual’s marginal tax bracket.   Foreign tax credits may be claimed against this tax.

If there is a tax balance, after claiming any foreign tax credits, the balance due can be paid over 8 years, with 8% being due in each of the first 5 years, 15% in year 6, 20% in year 7 and 25% in year 8.  The yearly balance due is due on the return’s normal due date without any extensions.

Though the legislation has been signed into law, full regulations have yet to be issued.  In late December the IRS issued IRS Notice 2018-007 but we expect further guidance.  We at, Cadesky US Tax, are current on these changes and can provide assistance in assessing the impacts.

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U.S. Tax Reform – Is It Permanent?

Ever since President Trump announced his candidacy for President, both he and the Republican Party have been pushing for tax reform primarily consisting of massive tax cuts. On September 27, 2017 President Trump released a document entitled “Unified Framework for Fixing Our Broken Tax Code” where he outlined his proposals.  On November 2, 2017 the House Republicans released the “Tax Cuts and Jobs Act H.R. 1” which echoed a significant number of President Trump’s proposals.  On November 9th, 2017 the staff of the Joint Committee on Taxation released document JCX-51-17, the Description of the Chairman’s Mark of the “Tax Cuts and Jobs Act” which is scheduled for Markup by the Senate Committee on Finance on November 13, 2017 (aka the Senate proposals).  There are quite significant differences between the Republican House and the Senate proposals.

The Joint Committee on Taxation is a nonpartisan committee of the United States Congress, originally established under the Revenue Act of 1926.  The Joint Committee is chaired on a rotating basis by the Chairman of the Senate Finance Committee, Orrin G. Hatch (R-Utah), and the Chairman of the House Ways and Means Committee, Kevin Brady (R-Texas).  The current Chairman is Senator Hatch.

Both the Republican House and Republican Senate plans call for lowering the individual and corporate tax rates, repealing numerous tax credits, eliminating the alternative minimum tax (AMT), enhancing the child tax credit, doubling the estate tax exemption, amongst other items.   Assuming that the versions will be reconciled and go to the President for signature and subsequent enactment, the question then becomes “Will these changes be permanent?”

Under current legislation the answer is no (ignoring any Democratic objections, the impact of Roy Moore on the Alabama Senate elections, etc.).  There is a provision in the Congressional Budget Act of 1974 process called the “Byrd rule”, named after the late Senator Robert Byrd of West Virginia.   This rule allows Senators, during the Reconciliation Process, to block a piece of legislation if it purports significantly to increase the federal deficit beyond a ten-year term or is otherwise an “extraneous matter” as set forth in the Budget Act.  A vote of 60 Senators is required to overturn the ruling.

The Joint Committee (JCX-54-17) estimates the static revenue loss from the (House) plan to total US $1.5 trillion over a decade.  Whether the increased deficit can be offset by revenue growth, generated by increased business activity in the economy, is a question of fact.

Since the current proposals are not revenue neutral, the legislation can only be made permanent if there are at least 60 votes in the Senate (to override the Byrd rule). Currently the Senate is comprised of 52 Republicans, 46 Democrats and 2 Independents (who caucus with the Democrats).  As such the Republicans do not have enough votes to override the Byrd rule.  The proposals, as they stand, would require significant changes to make them Byrd-rule compliant.  One option is provide sunset provisions of some of the tax cuts after a decade (anyone remember President Bush’s 2001 Economic Growth and Tax Relief Reconciliation Act estate tax provisions?).  Clearly the fun is just beginning.

The above  information is not intended to be “written advice concerning one or more federal tax matters” subject to the requirements of section 10.37(a)(2) of U.S. Treasury Department Circular 230. The contents of this document are intended for general information purposes only.