Apr 19, 2021
As you may know, we have supported a request to the CRA to extend the April 30 deadline to June 15. But if the deadline is NOT extended, here are some practical tips to reduce the burden of a COVID tax season.
We continue to receive queries from advisors and clients who do not understand how the U.S. Global Intangible Low Taxed Income (GILTI) rules will impact them. They read generic promotional pieces from financial advisory firms and banks, on various U.S. tax issues, and become worried over what they read. The intent of this U.S. Tax Tip is to provide an example of how the GILTI provisions may impact a U.S. citizen Canadian resident who owns a Canadian corporation that is carrying on an active business in Canada. Each client situation, however, is different and an appropriate analysis of a taxpayer’s specific facts need to be considered in determining how GILTI will impact them. The example below is meant to be for illustrative purposes only.
The IRC §962 election
Section 962 of the Internal Revenue Code (IRC) allows “in the case of a United States shareholder who is an individual and who elects to have the provisions of this section apply for the taxable year” to have his subpart F and GILTI income subject to tax at U.S. corporate rates as a hypothetical U.S. corporation. This election has been in place since January 1, 1963 (enacted as part of the Revenue Act of 1962, P.L. 87-834) as part of the subpart F regime. When the U.S. corporate tax rate was 35%, making this election was not beneficial to the taxpayer. Now that the U.S. corporate tax rate was reduced to 21%, making this election is now an option. What happens if the taxpayer makes this election?
The corporation still has $735 of retained earnings that can be distributed as a taxable dividend to the shareholder. When the taxpayer makes an IRC §962 election, there is (in general) no addition to the previously taxed earnings and profits (PTEP) pool. As such when the $735 is distributed, the income is taxed on the shareholder’s U.S. income tax return as a foreign source dividend. He will pay Canadian tax of $289 ($735 x 39.34%), just as he normally would regardless of what election was made for U.S. tax purposes. The current maximum U.S. personal tax rate on qualified dividends is 20%. As such the U.S. tax before any foreign tax credit is $147 ($735 x 20%). Since the associated Canadian tax of $289 would be in excess of the corresponding U.S. tax of $147, there will be no U.S. income tax. There may, however, be the U.S. Net Investment Income Tax (NIIT) depending on the taxpayer’s modified adjusted gross income, etc.
Even if an IRC §962 election is made, U.S. tax could arise in those provinces where the small business rate is quite low (remember only 80% of the actual corporate taxes are eligible to be claimed as a GILTI foreign tax credit). Manitoba, for example, has a zero provincial tax rate on small business income. For a CCPC in Manitoba the effective tax rate is 9% (the federal rate) on the first $500,000 of active business income. In the case of a Manitoba CCPC the Canadian corporate tax would be $90 ($1,000 x 9%). As such there would be a hypothetical U.S. corporate tax of $33 [($105 per 3) above) – $72 ($90 x 80%)]. Though there is a U.S. tax exposure, given the deferral of Canadian personal taxes, this option may still be a viable alternative.
The 2017 Tax Cuts and Jobs Act (TCJA) clearly added a lot of complexity with respect to U.S. citizens, Canadian residents who own Canadian corporations. In our opinion Congress, in their attempt to curb abuses (real or perceived) by large U.S. multinational companies, failed to consider the impacts of these changes on small business owners. Such taxpayers need to consider making the IRC §962 election in order to mitigate the potential impacts of GILTI.
Who we are
Cadesky U.S. Tax Ltd. is a full service advisory and compliance firm. We monitor U.S. tax news that may be of interest to our readers and share our thoughts in U.S. Tax Tips.
If you require our assistance please do not hesitate to reach out to us.
U.S. TAX TIP is provided as a free service to clients and friends of Cadesky U.S. Tax.
The material provided in this U.S. Tax Tip is believed to be accurate and reliable as of the date of posting. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither Cadesky Tax nor Cadesky U.S. Tax can accept any liability for the tax consequences that may result from acting based on the contents hereof.