U.S. Transition Tax
In December 2017, the U.S. enacted The Tax Cuts and Jobs Act (“TCJA”). Amongst many changes to U.S. tax law is a move to a territorial tax system where US corporate shareholders of non-U.S. corporations can repatriate profits earned outside the U.S. without additional U.S. tax. As part of this transition, many US shareholders are now subject to U.S. federal income tax on past profits remaining in certain non-U.S. corporations commonly referred to as Transition Tax (or Repatriation Tax).
The Transition Tax will affect many U.S. individuals resident in Canada who own Canadian and other non-U.S. corporations. All U.S. citizens and residents with interests in Canadian and other non-U.S. corporations should review their exposure to the Repatriation Tax. After April 17, 2018 a key strategy will cease to be available.
Does the Transition Tax Apply to You?
The repatriation tax applies to any non-U.S. corporation where over 50% of the combined voting power or value of shares is owned by U.S. persons who directly or indirectly hold 10% or more of the corporation’s shares. Repatriation tax also applies to non-U.S. corporations which have one or more U.S. corporations as a 10% direct or indirect shareholders, regardless of whether U.S. persons own more than 50%. The TCJA expanded the definition of applicable shareholders to include indirect and other constructive ownership situations.
How Transition Tax is Calculated
Transition Tax applies to the applicable U.S. person’s share of “Earnings and Profits” that have built up in the non-U.S. corporation and have not been distributed after 1986. While the term “Earnings and Profits” is similar to retained earnings, there are many differences and adjustments including depreciation, installment sales, corporate transactions, etc.
Earnings and Profits are determined as at November 2nd and December 31st, 2017. Transition Tax applies to the higher amount as determined on each date. The tax is calculated at either 15½% if they relate to assets in the corporation that are cash or cash equivalents (marketable securities, etc.) or 8% if the portion arising from other non-cash assets. The 15½% rate is applied first against Earnings and Profits until the cash and cash equivalents are fully-taxed. The balance of Earnings and Profits are taxed at 8%.
2017 Transition Tax – Deadlines
Qualifying US shareholders who hold interests in non-U.S. corporations that have a December year end need to pay the tax with their 2017 U.S. federal income tax return. For individuals and U.S. corporations (that also have December year ends), the due date is April 17, 2018. Amounts paid after this date may be subject to interest and penalties.
Transition Tax can also be paid in installments over 8 years by filing an election by the original due date of the return (April 17, 2018) and making the first installment payment (8% of the tax due) on a timely basis. The deadline for this payment cannot be extend.
Many Existing Tax Planning Strategies will be Eliminated – Be Proactive
Qualifying taxpayers who pay on an installment basis will not have interest charged on the unpaid installments. Foreign tax credits may also be available to reduce or eliminate the tax. US lawmakers have stated that many tax planning strategies that would reduce or eliminate this tax will be prevented either through provisions in the TCJA or future regulations. Some tax planning strategies are still available to help reduce or eliminate the tax.