In late 2017, the US Congress passed the Tax Cuts and Job Act (“TCJA”) which was signed into law by then President Trump on December 22, 2017. One of TCJA’s major changes was to reduce the maximum federal corporation income tax rate from 35% to 21%. In order to offset some of the tax revenue lost, Congress included a “repatriation tax” of 8% – 15.5%, which was applied to the foreign subsidiaries of US taxpayers on their undistributed earnings. Generally, tax payments could be made in installments over eight years.
The repatriation tax was intended to tax the offshore earnings of major multinational corporations such as Apple and Microsoft, as many large global organizations were trying to avoid paying the federal 35% maximum tax rate.
The wording of the law was that all earnings of Controlled Foreign Corporations (“CFCs”) were to be subject to the 35% tax rate. Many Canadian corporations, with majority US citizen ownership, were subject to the 35% tax often resulting in crushing US tax liabilities. To add insult to injury, as the US tax was applied at the US individual owner level, corporate level foreign tax credits were generally unavailable to mitigate the high tax rate.
Constitutionality of the Repatriation Tax
In an essay published in Yale University publication, a recent Stanford Law School graduate employed by Fenwick & West, a prestigious US law firm, the author challenged the constitutionality of the repatriation tax on the following basis:
- The Sixteenth Amendment allows for tax on income but not on wealth and is, therefore, unconstitutional, and
- If the repatriation tax is deemed to be a tax on income, the tax is unconstitutionally retroactive. While the US Supreme Court has generally upheld retroactive taxes, the potential of the repatriation tax to tax earnings as much as three decades old raised unprecedented Fifth Amendment Due Process concerns.
Recent Ninth Circuit Case
In Moore v. United States, No. 20-36122 (9th Circuit, June 7, 2022), the US Court of Appeals, for the Ninth Circuit, reaffirmed the government’s right to assert the repatriation tax and dismissed certain constitutional challenges.
The government believed that there is no constitutional ban on Congress disregarding the corporate form to facilitate taxation of the shareholders’ income. As the CFC owners had to have owned at least 10% of the CFC, they did have an ability to determine distributions from said corporation.
As for the Due Process Clause, the Court explained that the mandatory repatriation tax served the “legitimate purpose” of preventing CFC shareholders from obtaining a significant benefit by never having to pay taxes on their offshore earnings that have not yet been distributed.
It is important to note that, it is possible that the decision can be appealed at higher judicial levels, such as in the US Supreme Court.