Paul L. Caron
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Friday, November 24, 2023

Weekly SSRN Tax Article Review And Roundup: Eyal-Cohen Reviews Hanna's Moore, The 16th Amendment, And The TCJA’s Deemed Repatriation Provision

This week, Mirit Eyal-Cohen (Alabama; Google Scholar) reviews Christopher Hanna (SMU), Moore, the Sixteenth Amendment, and the Underpinnings of the Deemed Repatriation Provision, 76 S.M.U. L. Rev. F. 156 (2023).

Eyal-CohenOn June 26, 2023, the Supreme Court in Moore v. United States granted the taxpayer’s petition to hear a rare case involving the constitutionality of section 965 deemed repatriation, a provision that was added by the 2017 Tax Cuts and Jobs Act (“TCJA”). The question at subject is whether the Sixteenth Amendment authorizes Congress to tax unrealized sums under the deemed repatriation clause without apportionment among the states. Under section 965, a U.S. shareholder who owns 10% or more of a deferred foreign income corporation must include its pro rata share of the foreign corporation’s accumulated post-1986 deferred foreign income in its gross income (Subpart F income). The U.S. shareholder’s pro rata share of the foreign corporation’s cash position determines whether that amount is taxed at 8%, 15.5%, or both. 

In Moore, the taxpayer argues that Section 965 mandates the inclusion of deemed repatriated amounts as gross income without realization event. One of the foundations of the federal income tax system is the realization requirement, thus the taxpayer in Moore argues, without a realization event, the repatriation tax is not an income tax and must be apportioned among the states. 

With the various amicus briefs tax profs and others have recently filed re: Moore, I thought this Article provided an interesting historical angle necessary to understand the policy and context of the deemed repatriation. The Article describes the legislative history and the justifications behind the enactment of section 965 deemed repatriation provision from tax policy considerations of equity, efficiency, and simplicity. It argues that the realization doctrine was not discussed during Section 965’s enactment but was seen as a necessary part of U.S. international tax reform and aimed to tax U.S. multinationals’ unrepatriated income as a fair, efficient, and simple tax policy. Examining the history of the international tax reform under TCJA reveals that deemed repatriation was a tax-efficient approach. It covered historical profits and occurrences, estimated to produce a large amount of income, and limited distortion on investment. Simplifying the tax to post-1986 deferred foreign income was the main goal.

Congress significantly altered the U.S. foreign tax structure with the TCJA. Before TCJA, the U.S. operated a global deferral system with a credit for foreign income taxes. TCJA removed most of the deferral of U.S. tax and exempted a portion of the foreign subsidiary’s profits. Reforming the U.S. foreign tax system sought to minimize lock-out effects whereby U.S. corporations did not repatriate their international revenues from low-tax countries to escape the U.S. repatriation tax. Following the November 2010 Republican majority in the House, Representative Dave Camp (R-MI) then Chairman of the House Ways and Means Committee, made comprehensive tax reform his top policy priority. Even though he was no longer in Congress when tax reform was finally passed in December 2017, the author notes he was the most influential person behind the first successful tax reform effort in over 30 years. Camp’s tax reform efforts began in early 2011 and included a discussion draft for international tax, which deferred U.S. tax on revenue produced by a controlled overseas firm until the corporation repatriated it. Camp suggested changing the U.S. foreign tax structure from global deferral to territorial in the discussion draft by which a U.S. multinational can deduct 95% of overseas subsidiary profits while being subjected to a 5.25%-taxed presumed repatriation of overseas earnings and profits over eight years. The estimates of cumulative foreign profits were $1–$1.5 trillion under Camp’s discussion draft. The late Senator Mike Enzi (R-WY) issued his international taxes discussion draft a few months later, which included slightly different rates.  After the 2011 discussion draft was released, Camp received extensive criticism that the 5.25% rate burdened accumulated foreign profits since a large amount had been re-invested in foreign non-liquid assets. Due to the then high U.S. residual tax, several U.S. corporations kept huge quantities of international revenues in low-tax countries as cash and cash equivalents and refused to repatriate them. The gap between profits reinvested in non-liquid assets and retained overseas versus cash, caused businesses to push for a lower tax on non-liquid assets than cash and cash equivalents under U.S. tax.

Camp unveiled his proposal in the Tax Reform Act of 2014 draft, advocating a two-tier rate schedule for accumulated foreign profits in moving to a territorial international tax system. The Camp plan would repatriate and tax cash-held post-1986 overseas profits at 8.75% after a 75% reduction. Any residual non-cash post-1986 accumulated overseas profits (such as foreign income reinvested in property, plant, and equipment) would be repatriated and taxed at 3.5% after a 90% deduction. The taxpayer might pay over eight years. Chairman Camp’s 2014 proposal also allowed non-corporate taxpayers owning 10% or more of a foreign corporation subject to the deemed repatriation provision to avoid paying their share of the tax on accumulated foreign earnings. The plan permitted individual taxpayers to deposit their shares to a subchapter S company to delay tax payment until a triggering event. The triggering events, which would have required prompt payment of the whole tax, usually included transactions that might transfer foreign company shares to a U.S. corporation qualified for the section 245A dividends-received deduction. As finally enacted the new U.S. foreign tax structure under TCJA eliminates lock-out. Many CFC profits will be taxed yearly to U.S. shareholders without deferment or repatriation tax at a single 14% rate on accumulated foreign income. Deferred CFC profits may be repatriated tax-free under section 245A 100% dividends-received deduction. For sake of simplicity, in his 2014 tax proposal, Camp confined the considered repatriation option to post-1986 cumulative deferred foreign income as firms argued they only kept trustworthy records from that time onward. 

While reviewing the history of the repatriation clause, the author demonstrates that Congress focused on how to tax the cumulative overseas revenue held by foreign subsidiaries of U.S. owners, many of whom are U.S. multinationals, while enacting the new U.S. international tax framework as part of TCJA. This overseas revenue was generated by foreign subsidiaries but not repatriated due to the lock-out effect. Equity, efficiency, and simplicity dominated tax policy and reform discussions. TCJA changed the U.S. international tax system from a worldwide deferral system to a territorial system. U.S. multinationals had accumulated well over $2 trillion in foreign earnings at the time of enactment, with $1 trillion in cash, mostly held in U.S. fixed income securities. Congress considered switching to a territorial tax system with a free pass for accumulated foreign earning, but such a system would unfairly benefit certain multinationals and exclude much-needed revenue. It did not seem fair that a U.S. multinational that did not repatriate its earnings from its CFCs before tax reform would pay no U.S. tax on such earnings while a multinational that repatriated earnings immediately prior to tax reform would pay a 35% top corporate tax rate on such earnings less any associated foreign tax credits. Congress concluded that the easiest and most fair answer was to erase accumulated profits off taxpayers’ records without handing them a windfall—taxing such past earnings once, at lower rates, and never again. 

After repatriating revenues overseas, there was a concern regarding U.S. shareholders owning an interest in a foreign corporation with an aggregate foreign earnings and profits deficit. Could the pro rata share of the deficit offset the pro rata share of the accumulated deferred foreign income, resulting in a net mandatory inclusion amount? Congress agreed to allow a CFC’s earnings and profits deficit to offset the U.S. shareholder’s pro rata share of another CFC’s accumulated deferred foreign income. This approach was consistent with Camp’s 2011 and 2014 tax proposals. The new U.S. international tax regime also taxed tested income or global intangible low-taxed income (“GILTI) on a net or overall basis rather than country-by-country. Congress set the rates with two principles: no windfall to U.S. corporations and no benefit to the government. If all profits are repatriated immediately and taxed at the full U.S. rate, the government would benefit. It would be worse than U.S. multinationals expected. These corporations legitimately anticipated and depended on indefinite postponement. With the lock-out effect, required repatriation was important to prevent a windfall for U.S. multinationals, particularly compared to firms who returned revenues before the TCJA. 

Another challenge was structuring the tax on presumed repatriated profits for efficiency. Tax provisions that do not interfere with or distort taxpayers’ investment or hamper economic growth, which was an important strategic goal of the 2017 tax reform. Depending on the rate or rates, a deemed repatriation provision could raise $300 billion or more over the ten-year budget period, bringing the total cost of tax reform legislation below $1.5 trillion in accordance with firm labor and capital, factor productivity, and long-run aggregate demand equal supply at full employment. The top corporate tax rate was reduced from 35% to 21% in the TCJA, and other proposals like the deemed repatriation provision were considered in 2017 to raise revenue fairly and efficiently. Another proposal under consideration during the tax reform process was to tax a domestic corporation on its accumulated earnings and profits and then either provide tax-free dividends to shareholders or give shareholders a credit for the tax paid by the corporation. A tax on a corporation’s accumulated earnings and profits, like the presumed repatriation provision, would have efficiently raised a lot of money at a low rate, causing little distortion to investment or business choices and at no negative influence on economic development. Yet, this idea never progressed. 

The Article concludes by pointing out that presumed repatriation clause was essential to the TCJA’s U.S. foreign tax structure. Moving from a global to a territorial tax system necessitated taxing the deferred overseas income of U.S. owners’ foreign companies taxed for fairness and simplicity policy reasons. Providing taxpayers with deferred foreign income a free pass would have been unfair because some U.S. multinationals would receive a windfall for keeping their earnings abroad, while others repatriated their earnings at a 35% corporate tax rate less foreign tax credits before TCJA. In addition, taxing it on a required rather than elective basis reduced the lock-out effect, which would have existed if pre-TCJA deferred foreign income were still subject to a U.S. residual tax when repatriated voluntarily. The tax rates were also crucial. Because firms believed they could avoid repatriation forever, taxing at the full corporate rate would have given the government a windfall. Thus, preferential rates that took into account firms’ reduced tax obligation estimates struck a reasonable compromise.

Here's the rest of this week's SSRN Tax Roundup:

https://taxprof.typepad.com/taxprof_blog/2023/11/eyal-cohen-reviews-hanna-moore-the-16th-amendment-and-the-tcja-deemed-repatriation-provision.html

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