Potential protective refund opportunity for US citizens impacted by repatriation tax

Posted -

Our US citizen client base had been significantly and adversely impacted by the tax imposed on the retained earnings of their Canadian corporations. An opportunity may exist to file a protective refund claim in 2021 and later years to protect the client’s right to receive a refund of the tax paid.

Background

On December 22, 2017, a sweeping US tax reform bill was enacted. As part of the bill, US-based multinational corporations are now allowed to repatriate earnings of a foreign subsidiary on a tax-free basis beginning in 2018. The tax-free treatment is not available to US citizens or residents owning foreign corporations including Canadian corporations.

In “exchange” for prospective tax-free repatriation, US corporations and individual taxpayers were required to pay a repatriation tax based on their corporate earnings and profits as of either November 2, 2017 or December 31, 2017 (i.e. whichever was greater) equivalent to 15.5% of cash or cash equivalents therein or 8% for non-cash items. Said tax could be paid in installments over eight years.

Recent Developments of Interest

  • Federal Express (“FedEx”) has indicated that it will be challenging the IRS’s interpretation of the rules as issued in the proposed regulations last August. FedEx has refused further public comment on the basis on their challenge.
  • The Bloomberg news service has indicated that several other US based multinationals are weighing challenges to the law.
  • The Joint Committee on Taxation has released its explanation of the new law in which it provides that corporations must limit the use of foreign tax credits against the tax but does not mention that individuals are subject to the same limitation. This would seem to provide either tacit support or IRS ambiguity on an aggressive position we took on many clients accessing their full foreign tax credits to offset the repatriation tax.

Constitutionality of the Tax

There are two strong arguments supporting the fact that the repatriation rules are unconstitutional.  The first is that the tax is an unconstitutional tax on accumulated wealth.  Second, if it can be demonstrated that the tax is on income, as opposed to wealth, there are numerous cases supporting the notion that a retroactive tax cannot go back more than a year at most.

How This Could Play Out

It is likely that over the next few years either a US corporation which had no intention of ever repatriating the earnings or a US individual whose corporate holdings were subject to the tax will challenge the constitutionality of the law. Should that happen, there is a good chance the taxpayer will succeed in overturning the law.

If a successful challenge is initiated, it will take years for the audit of the taxpayer and administrative and judicial remedies to be exhausted. In the likely event that it will take more than three years, the taxpayer’s ability to get prior taxes paid to be refunded may be barred by the statute of limitations.

Our Plan for Action

At Zeifmans, we will monitor developments in this area. While it is impossible to prognosticate the timing or outcome of the challenges, we believe that there is a good chance of the law being declared unconstitutional.

For our clients, the plan is to file protective refund claims for 2017 tax returns sometime in 2021 prior to the expiration of the statute of limitations in order to preserve our clients’ rights to obtain refunds should the law be declared unconstitutional at a later date.

Filing earlier protective refund claims or omitting the tax from 2018 and later returns could put our client base in the forefront of a fight which would be better off funded by FedEx and other deep pocked public companies adversely impacted by the law.

Should you have questions regarding this matter, please contact Stanley Abraham, Zeifmans’ US Tax Partner at 416. 256.4000 ext 356.