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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