Paul L. Caron

Friday, February 9, 2024

Weekly SSRN Tax Article Review And Roundup: Roberts Reviews New Articles On Moore v. United States By Avi-Yonah & Clarke

This week, Tracey M. Roberts (Cumberland; Google Scholar) reviews new works by Conor Clarke (Washington University; Google Scholar), Moore: The Overlooked Excise Power, 181 Tax Notes Fed. 1759 (Dec. 4, 2023) and Reuven Avi-Yonah (Michigan; Google Scholar), Effects from Moore: Does the Corporate Tax Require Realization, 182 Tax Notes Fed. 661 (Jan. 22, 2024).

Roberts (2020)

A tax case on an obscure provision in the Tax Cuts and Jobs Act has captured the attention not only of tax specialists, but the broader public. Rightly so. If decided in favor of the Moores, it could be the most consequential decision since Citizens United v. Federal Election Commission, which held that the freedom of speech clause of the First Amendment prohibits the government from restricting corporate expenditures for political campaigns. In Moore v. United States, the Moores take issue with the Mandatory Repatriation Tax (or “MRT”) set forth in I.R.C. section 965. The MRT is a one-time tax levied on the undistributed earnings and profits of specified foreign corporations dating from 1986, when Congress enacted provisions that shielded those earnings from taxation. Following Congress’s repeal of those provisions and the addition of the MRT under the Tax Cuts and Jobs Act, the MRT would tax that income, at a lower rate, to the shareholders whose holdings exceed a 10 percent threshold. 

The Moores have asked the U.S Supreme Court to strike down the MRT as an unconstitutional direct tax that fails to satisfy the apportionment clause under Article I. All “direct taxes,” generally thought, during the country’s first 100 years, to encompass only per capita taxes and taxes on real property, are required to be apportioned among the states according to population, per Article I, section 2 and section 9 of the Constitution. In 1895, the U.S. Supreme Court held in Pollock v. Farmers' Loan & Trust Co. that the Income Tax of 1894, which included taxes on income from property, was a direct tax  on property and was unconstitutional because it was not apportioned. Nearly 20 years later, the 16th Amendment to the Constitution, enacted and ratified in 1913, affirmatively extended congressional power to tax incomes “from any source derived.” The Moores also argue that the 16th Amendment requires that for income to be subject to the income tax, it must be realized (distributed to the taxpayer in cash).

From new factual revelations not disclosed in the Moores’ pleadings, and from Reuven Avi Yonah's analysis of the structure of the holdings of the controlled foreign corporation in which the Moores own an interest, we have learned that Charles Moore was once a director of KisanKraft, that he has a close relationship with the founder, and that there were good tax and business reasons and pathways both for KisanKraft to avoid status as a controlled foreign subsidiary and for the Moores to avoid not only the MRT, but all kinds of liabilities to which they are currently exposed. The KisanKraft founder holds most of his own interests in the company indirectly through a U.S. holding company. Why the Moores invested directly in KisanKraft rather than in their friend’s holding company remains a puzzle. Avi Yonah concludes that the Moore case, with a $40,000 investment (small enough to generate some sympathy, but large enough to overcome the 10% threshold) and a $14,000 tax liability, appears to have been engineered specifically to challenge section 965. Clearly the Moores have drawn more sympathy than the multinational corporations who would enjoy a refund of their $349 billion in mandatory repatriation taxes if the Supreme Court were to hold MRT unconstitutional. (The Roosevelt Institute and the Institute on Taxation and Economic Policy have broken down by industry the tax giveaway that would result from a decision in favor of the Moores.) Nevertheless, the Court has yet to follow the recommendation of Michael Graetz (Yale, Columbia) to dismiss the case as improvidently granted.

The Joint Committee on Taxation has clarified that the implications of imposing realization as a constitutional requirement are vast, affecting not only the ability of the United States to tax foreign income under Subpart F and the global intangible low-taxed income (GILTI) regimes, but also the taxation of partnerships, S corporations, real estate mortgage investment conduits, original issue discount (interest), below-market and short-term loans, imputed rental income, as well as the mark-to-market taxation of securities dealings and insurance companies and the exit tax under I.R.C. section 877A. Daniel Hemel (NYU; Google Scholar) has further discussed what’s at stake in the case for the Moores, for Congress, and for the public.

Reuven Avi-Yonah (Michigan) has examined possible off-ramps and concluded that there's little likelihood that that the damage to the tax system of a decision in favor of the Moores can be limited. Even if one of those off ramps were taken, Mindy Herzfeld (Florida) has explained that the Moore case is not the end of constitutional challenges to the modified international tax regime developed under the Tax Cuts and Jobs Act. In Altria Group, Inc. v. United States, the company has asked the court for what would appear to be narrow relief in striking down the constitutional validity of subpart F only as applied to its specific facts regarding constructive ownership through downward attribution. As Herzfeld has pointed out, however, this would tank the application of the GILTI regime in subsequent years. The Altria case has been stayed pending the outcome of Moore.

Many tax scholars and experts, tax practitioners, businesses, nonprofit organizations, and states have written four dozen amicus (friend of the court) briefs addressing the issues before the Court. Much of the analysis has been focused on an originalist meaning of the phrase "taxes on incomes" prior to, during, and shortly after the ratification of 16th Amendment and the passage of the Underwood-Simmons Tariff Act of 1913, lowering tariff rates and introducing a new federal income tax.

Jake Brooks (Fordham; Google Scholar) and David Gamage (Indiana-Maurer moving to Missouri; Google Scholar) have written a series of deeply researched articles that clarify the historical record, and explain that the original understanding of the Sixteenth Amendment allowed for an income tax that included potential taxes on unrealized gains. Joseph Thorndike has discussed the relevant writings of the most influential economists of the era, Edwin R.A. Seligman and Robert Murray Haig, tracking their debate. Jonathan Grossberg (Google Scholar), Kerry Inger (Auburn; Google Scholar) and Carniel Wilson, in Moore v. United States and The Original Public Meaning of "Taxes on Incomes," have examined state income tax measures from the colonial period through to and after the Civil War, showing that many such taxes were estimated and lacked any concept of, or reference to, realization. They have also examined the legislative history and discussions within influential tax and accounting bodies, including the National Tax Association and the American Economic Association. Their coverage of the discussions around the use of accrual accounting to measure corporate income in the period immediately prior to the adoption of the 1913 income tax are of particular interest, since accrual accounting does not require realization for recognition of income, and of course, requiring realization as a constitutional matter would likely scuttle the accounting system of the majority of corporations in the United States. They survey newspaper articles, expand on Thorndike's coverage of the thought of economists and experts of the era, and finally wind up discussing the congressional debates in which the primary author of the 1913 income tax, Cordell Hull, was asked about the taxation of appreciation of stocks, with Hull answering in the affirmative

Finally, more recently, two scholars have asked whether the Supreme Court’s inquiries in Moore and Atria should pivot away from examining whether the TCJA provisions constitute an Article I, section 2 and 9 direct tax or a 16th Amendment income tax on the accrued but undistributed income of a foreign corporation. Instead, they ask whether the provisions may be upheld as an excise.

In  Moore: The Overlooked Excise Power, 181 Tax Notes Federal 1179 (Dec. 4, 2023), Conor Clarke argues that the MRT should be upheld as an excise tax under Article I, Section 8, which grants Congress the power “to lay and collect Taxes, Duties, imposts and Excises.” The excise power is subject to the requirement that “all Duties, Imposts and Excises shall be uniform throughout the United States.” The uniformity requirement posts a fairly low bar, since the Court has interpreted it to require only that the tax be applied uniformly wherever the subject of the tax appears throughout the country. Clarke recounts numerous cases in which Congress has imposed, and Supreme Court has upheld, excise taxes to raise revenue from business activities, including excises on both individuals and the gross receipts of companies engaged in the insurance business, and excises on retailers of foreign alcohol and foreign merchandise. Clarke notes the similarities in the subject matter of some of these taxes to that of the MRT. During the Civil War, Congress used the excise power to impose taxes on sugar refiners, advertising and insurance businesses, and license fees that scaled with the size of the enterprise or the quantity or value of output on a variety of other trades and businesses. Clarke’s analyses are further supported in other cases that Gamage and Brooks collect in what they call the “Excise Canon”.

In Flint v. Stone Tracy Co., 220 U.S. 107 (1911), the U.S. Supreme Court upheld the 1909 corporate tax on corporate earnings and profits as an excise tax on “doing business in a certain way.” Clarke argues that likewise, the MRT may be upheld as a tax of doing business as a foreign corporation. Clarke notes that in the Pollock case, which struck down the 1894 income tax, the Supreme Court expressly declined to consider the legal status of “taxes on gains or profits from businesses, privileges or employments” in view of the instances in which those taxes had been sustained in earlier cases. In Stone Tracy, the Court sought to clarify the distinction between “doing business” and “having” or “holding” property.  Clarke argues that anyone who puts their capital in corporate equities may be said to be doing business in a particular way, and urges the Court to consider that Congress has clarified the “doing” versus “having” divide by imposing the RMT only on U.S. shareholders who own 10 percent or more of the total combined voting power of the foreign corporation.  Clarke ultimately argues that the Supreme Court should remand to the lower courts to opine on whether the MRT qualifies as an excise.

Reuven Avi-Yonah also examines the characterization of the corporate tax as an excise in Effects from Moore: Does the Corporate Tax Require Realization, Tax Notes (Jan. 22, 2024). Avi-Yonah is more skeptical, reviewing the literature in view of the challenge to the realization requirement in the Altria case. He begins by recounting President Taft’s June 16, 1909 address to Congress, which states (1) that the corporate tax was an excise on the privilege of doing business as an artificial entity and of freedom from a general partnership liability enjoyed by those who own the stock, (2) that it is administrable, in that it imposes a burden at the source of income at the time when collection is easy and the corporation is able to pay, and (3) that the tax allows the federal government to collect information needed for oversight of corporate business affairs. Avi-Yonah first focuses his attention on the latter two arguments, concluding that the tax was not an excise at all, but a pathway for the government to tax rich shareholders when they could not be taxed otherwise, and to regulate businesses as an alternative to anti-trust regulation. He seems to imply either that these demands have met in other ways and / or that the corporate tax may not be an appropriate mechanism for such activities.

Third, Avi-Yonah takes up President Taft’s “corporate privileges” explanation, and argues that the argument is inapposite, since the modern corporate tax is also imposed on businesses that do not enjoy the corporate privilege of a shield from liability, such as publicly traded partnerships. However, corporations and their shareholders (and PTPs and their members) and other business entities subject to the corporate tax enjoy many privileges, including the ability to raise capital through public trading within the United States, the enjoyment of many, many tax and other subsidies from the U.S. government, the ability to own foreign subsidiaries, and to shift, hold, and harvest those tax and other benefits abroad. Furthermore, higher-level governance is needed to solve the collective action problem associated with taxation and regulation. Even though domestic corporations are incorporated and governed at the state level, the states themselves at the time of the 1909 corporate tax were, and continue to be, in competition with one another, in a race to the bottom in terms of regulation and oversight. Historically, the corporate tax has granted insight into dealings and practices that were harmful to society. Likewise, one hundred plus years later, the collective action problem has been replicated at the global level. The argument in favor of an excise on “the privilege of doing business in a certain way” still has legs. One has only to look at the tax preferences delivered to private equity and hedge funds (which enjoy passthrough treatment as well as the “carried insterest loophole) and contrast those benefits with the ill affects of their tinkering over the last two decades to understand that we are subsidizing their increasing market power. Moreover, tax fairness retains resonance for U.S. domestic businesses that must compete with multinational entities along many lines, including taxation.

Avi-Yonah notes that while the Court had earlier upheld taxes based on the way that Congress had characterized them, the Court had more recently declined to follow that reasoning in NFIB v. Sebelius, upholding the individual mandate for health insurance as a tax rather than as a penalty. Conor Clarke agrees with Avi-Yonah on the Congressional characterization issue, though he concludes that the MRT is an excise. Avi-Yonah argues that the corporate tax does not fit well within the excise rubric. He argues that the earlier corporate “excises” were close substitutes for excises on oil and sugar, and their incidence fell largely on consumers. Avi-Yonah further questions the integrity of the Stone Tracy decision, arguing that Congress was desperate, following the Supreme Court’s Pollock decision, to find a pathway to skate clear of the direct tax controversy. He argues that it was out of expedience that Congress characterized the corporate tax as an excise. In reality, he says, it was and is an income tax. Note that the U.S. Supreme Court upheld the original income tax enacted during the Civil War as “within the category of an excise or duty.” It was the Supreme Court’s Pollock decision that recharacterized taxes on income from property as “direct taxes” on property, delivering the boon of another 20 years of tax-free accumulation to capitalists in the Northeast. Tax scholars and historians delving into the earliest applications of excise taxes, have found that excises were levied either per quantum, based on weight or volume, or based on price, consistent with common usage of the term today. If the Court wishes to restore the original meanings of “income” and “excise,” then overturning the Pollock decision would be the first step. Whether the current Supreme Court is willing to do so is the question.

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

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