What is my U.S. taxable year (as it relates to certain Canadian corporations)?

Volume No. US-18-12

The recently enacted U.S. Tax Cuts and Jobs Act introduced new IRC §965, “Treatment of Deferred Foreign Income Upon Transition to Participation Exemption System of Taxation.” This onetime tax imposes a “repatriation or transitional tax” on United States shareholders of “specified foreign corporations”.

The term “specified foreign corporation” is defined to mean “(A) any controlled foreign corporation, and (B) any foreign corporation with respect to which one or more domestic corporations is a United States shareholder.”

Many U.S. persons (U.S. citizens or lawful permanent residents) who are resident in Canada own interests in Canadian companies.  If that U.S. person owns 10% or more of the votes or value (the value test being new as of January 1, 2018) then that person is defined to be a “United States shareholder”.  If “United States shareholders,” in aggregate, own more than 50% of the votes or value of the Canadian company that company is a controlled foreign corporation (CFC) and hence a specified foreign corporation for purposes of the repatriation or transitional tax.

The timing of the income inclusion to the shareholder, which then determines when the transitional tax is due, is based on the year end of the specified foreign corporation (i.e., Canadian company).  If the company follows a calendar year the income inclusion is December 31, 2017.  If the company follows a fiscal period, the income inclusion is the year end of the last fiscal period that began before January 1, 2018. For example, if the fiscal year was October 1, 2017 to September 30, 2018, the income inclusion occurs on September 30, 2018.

Many Canadian companies select a fiscal period other than that of the calendar year.  This could be for natural business reasons. For example retailers may select a January 31 year end instead of December 31 to account for the Christmas season. Others may choose a non-calendar year end to defer the taxation of income as long as possible.  In many cases it is not an issue for Canadian tax purposes. For U.S. tax purposes, however, the company may not have a choice.

IRC §898 outlines what the taxable year should be of certain foreign corporations.  In general, the determination of the “required year” is

  1. the majority U.S. shareholder year, or
  2. if there is no majority U.S. shareholder year, the taxable year prescribed under regulations.

Let’s look at a typical situation in Canada, a U.S. citizen resident in Canada who owns 100% of the shares of a Canadian operating company.  The Canadian company is a CFC for U.S. tax purposes since the U.S. citizen Canadian resident owns 100% of the votes and value of the company.  As he is the majority U.S. shareholder, the year of the company should be the same year as he has.

IRC §441(a) states “Taxable income should be computed on the basis of the taxpayer’s taxable year.”  The provision then goes on to define the term “taxable year” to mean the calendar year if certain conditions are not met.

In general, a calendar year is mandatory for an individual who keeps no books, does not have an annual accounting period, or has an annual accounting period that does not qualify as a fiscal year. It is possible for an individual to have a fiscal year but in the vast majority of cases the conditions are not met meaning that they would default to a calendar year filer.

What this means, in our example, is that the reporting period for U.S. tax purposes, of the Canadian company, should be the calendar year NOT a fiscal year since the majority U.S. shareholder’s taxable year is the calendar year.

In our experience the IRS has not addressed the issue of fiscal reporting periods of Canadian CFCs. This could be for many reasons including (i) there is no loss to the U.S. treasury (since non subpart F income is only taxed when distributed); (ii) the taxpayers may to be too small to warrant IRS examination; (iii) the IRS may not be aware of this issue or possibly; (iv) Congress simply does not understand the issues of U.S. citizens living abroad (as evidenced by many of these new rules).

With respect to the IRC §965 income inclusion it raises a potential issue – do fiscal specified foreign corporations need to adjust to a December 31st, 2017 year end to be in compliance with the Internal Revenue Code?  To date, the IRS has not issued any guidance on this point.  Taxpayers, however, need to be aware that they may not be technically in compliance.


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