Part of President Trump’s sweeping tax legislation enacted in 2017 which was meant to affect large multinational corporations like Apple and Google is also catching US citizens and green card holders who have interests in companies outside the US.
The so-called “repatriation tax” was intended to encourage US companies to bring money being held offshore back to the US. In other words, Apple’s profits fell (and remained) too far from the tree. Based on some reports, the new law seems to be having its intended effect. Technology giant Cisco Systems announced on Valentine’s Day that it would move $67 billion of cash to the US.
However, the law also requires individual US taxpayers who own foreign corporations – everyone from architects to apple farmers – to pay tax on a deemed repatriation of all profits that have accumulated in those companies since 1986. And because the testing dates for whether accumulated profits are subject to this tax were in November and December of 2017, many individuals will find that the deemed repatriation has already occurred and that the first payment of tax will be due as soon as 15 April.
While the law implementing the “repatriation tax” is complex in its detail, the concept is (relatively) straightforward. If a foreign company has any significant US owners (at least 10 percent), it must determine its accumulated “earnings and profits” (broadly, its retained earnings) as of both 2 November and 31 December 2017. The significant US shareholders are then taxed on their share of the higher of these two numbers, regardless of whether they receive anything from the company.
The tax rate that applies to this “deemed repatriation” of profits is based on whether the foreign company’s assets are treated as held in cash or non-cash assets as of 31 December 2017. The tax rate calculation is somewhat convoluted but, broadly, to the extent that retained earnings are viewed as held in cash, the significant US individual shareholder would be taxed at a top rate of 17.5 percent, while if the retained earnings are viewed as held in non-cash assets, the top tax rate is approximately 9.05 percent. “Cash” assets include cash as well as publicly traded stock, US Treasuries and any other government securities, foreign currency and accounts receivable (less accounts payable).
For US individual owners of most foreign companies, the repatriation tax applies for the 2017 tax year. In other words, they must calculate and pay this tax (or at least the first installment) by 15 April 2018.
The repatriation tax can be paid in installments over an 8 year period, with 8 percent of the liability due in the first five years, followed by 15 percent in the sixth year, 20 percent in the seventh year and 25 percent in the eighth year (owners of “S corporations”, a type of US “hybrid” corporation can elect to defer the tax liability in its entirety until certain “triggering events” occur).
Interest does not accrue on the installments provided they are timely paid. While the installment approach allows US individual shareholders to spread the tax payment over a longer period of time, it does not change the fundamental point: the shareholder is being taxed on amounts that have not been distributed (and in some cases may be extremely difficult to distribute).
While the repatriation tax is burdensome enough for significant US individual shareholders who live in the US, it is even more onerous for those who live outside the US. In either case, unless the shareholder makes a special election, they cannot claim any credit for taxes the foreign company paid on the retained earnings over the years. Further, actual distributions from the foreign company (for example, for cash to pay the repatriation tax) may be taxed again in the local jurisdiction.
It is not clear that the shareholder can credit any local tax paid on the distribution against the repatriation tax. Even if they can, the shareholder will have paid tax twice (once to the US on 15 April 2018 for the first installment of the repatriation tax and then to the local jurisdiction when they receive a distribution) and must request a refund from the US tax authority.
The repatriation tax was pitched as a necessary evil in a move to a “territorial” tax system, under which future non-US earnings would be exempt from US tax. However, the reality is that for US individual shareholders in particular, several other provisions in the new tax legislation ensure they are taxed on almost all income earned through foreign corporations on an arising basis going forward, even if they do not receive distributions. As a result, the repatriation tax may be best viewed as a first step to an even broader worldwide tax system – one with significant implications in the near term.
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