In recent years, one of the most hotly debated tax issues in the United States has been the imposition by Internal Revenue Code Section 965 of the “transition tax” or “mandatory repatriation tax”, a provision of the Tax Cuts and Jobs Act (TCJA) enacted in 2017. The Supreme Court’s recent decision to review the 9th Circuit case of Moore v. United States has brought this contentious issue back into the spotlight. The highest court in the US will determine whether the realization of income is a constitutional requirement for Congress to impose a tax. The US Court of Appeals for the Ninth Circuit held that realization of income is not a requirement. Well, we shall see about that.
In this blog post, we will explore what Section 965 is and why it’s under review. Part II of this blog will examine the possibility of filing protective refund claims as we await a decision by the US Supreme Court.
Understanding Section 965 Transition Tax
Section 965 of the Internal Revenue Code was introduced as part of the TCJA to address concerns about the offshore earnings of US multinational corporations. The provision required US shareholders of certain foreign corporations to pay a one-time transition tax on their accumulated post-1986 foreign earnings, regardless that those earnings had not been repatriated to the United States. The transition tax was intended to move the US international tax regime into a “territorial system”. In making the transition, US shareholders of certain foreign corporations, referred to as “deferred foreign income corporations” were compelled to pay a one-time “deemed repatriation tax” on the past earnings that had been accumulating over the years in the foreign corporation. Prior to enactment of the transition tax, tax on a company’s offshore profits could generally be deferred until the money was brought back to the US. The Joint Committee on Taxation, estimated the transition tax would generate $338.8 billion in tax revenue over a 10 year period. Full details on the transition tax and how it is calculated are at my blog posts here and here.
The transition tax has been the subject of controversy since its inception and now the US Supreme Court will have the final say once it decides Moore v. United States.
Moore v. United States: The Case at Hand
The Moore’s were individual taxpayers who invested in 2006 in a corporation formed in India to assist rural farmers. The Moore’s held close to 13 percent of the company’s common shares, but they (along with all the other shareholders) never received a distribution of any kind from the company since the company reinvested all profits to grow the business. Under Section 965, the Moore’s had to pay the transition tax based on the portion of the company’s earnings from 2006-2017 that reflected their 13% ownership.
The Moore’s paid the tax but filed a refund suit in district court in Washington. They argued that the transition tax was unconstitutional on two alternative grounds: it violated the Sixteenth Amendment since it did not impose an “income” tax, but rather imposed an “unapportioned direct tax”; alternatively they argued that Section 965 violated the Fifth Amendment’s Due Process Clause because of it was a new tax having a retroactive effect. The district court ruled against the taxpayers and the Ninth Circuit affirmed.
The taxpayers petitioned the US Supreme Court for review relying solely on ground that the tax violates the Sixteenth Amendment . The essence of this argument is that Section 965 is not a tax on income within the meaning of the Sixteenth Amendment, but that it is a direct non-income tax that the Constitution requires must be “apportioned” among the states on the basis of population. (More detail here on this requirement). The Moore’s decision to drop the retroactivity prong of their argument was a good decision since precedent has demonstrated that retroactive tax laws are generally very permissible. Not much stands in the way of retroactivity!
The Supreme Court’s decision to review this case suggests a significant development in the ongoing debate surrounding Section 965 as well as pointing to the possibility of challenge to other US tax laws that impose an income tax despite the fact that no income has been realized. Subpart F income, GILTI, Code section 877A (expatriation tax), and section 884 (branch profits tax) jump to mind. The outcome of this review could have far-reaching implications for US taxpayers with offshore interests and the interpretation of tax law.
Stay tuned for Part II of this blog post and learn what actions can be taken to protect a possible refund claim.
Posted August 24, 2023
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