Although the 2017 US Tax Cuts and Job Act (TCJA) aimed to cut taxes for all Americans, individual US shareholders of controlled foreign corporations (CFCs) living outside the US (expats) are being discriminated against under the repatriation and GILTI tax regimes. Monte Silver of Silver & Co. in Israel, explains why the likes of Google and Apple are getting a better deal than expats who may be driven out of business or forced to become tax evaders.
Despite the good intentions of the US government to cut taxes for all, the TCJA was rushed through Congress to allow the Republicans to achieve a significant legislative win in 2017. To quote a witness who testified at the April 24 Senate finance hearing on the initial impact of tax reform: “some of the international reforms like [the repatriation tax and GILTI] were not sufficiently thought through”. One of the unintended consequences of the rushed legislation was the harsh impact of the repatriation tax and global intangible low taxed income (GILTI) regime (the ‘new taxes’) on expats.
The expat vs. the multinational corporation
The repatriation tax was aimed at large US companies like Apple and Google which, for years, had shifted an estimated $2.6 million in profits to offshore subsidiaries to avoid high US corporate tax rates. The repatriation tax requires these multinationals to pay a one-time tax on these offshore profits. The tax is 15.5% for profits held in cash form, and 8% for profits held in non-cash form, all taxed from the first dollar of profit.
So, how is this relevant to an expat with a small business? The repatriation tax is a one-time add-on to the CFC regime. Under Internal Revenue Code section 957(a), a CFC is defined as a foreign corporation where more than 50% of the corporation’s voting stock or value is owned by US shareholders. Section 951(b) of the Code defines a US shareholder as a US person who owns 10% of the foreign corporation’s stock. In addition, sections 957(c) and 7701(a)(30) state that a US person includes a US citizen or resident, not only a US domestic corporation. In other words, if an individual American residing in country X runs a small restaurant that is a wholly owned corporation incorporated in that country, for purposes of the repatriation tax, that individual is treated like Google (the parent corporation) and the corporation (in this example, the restaurant) is treated like a Google foreign subsidiary. The result is that the expat is subject to the same repatriation tax as Google. But there is one catch: while Google pays 15.5% or 8% tax, the expat pays 17.54% and 9.05%, respectively.
This difference occurs because for each type of US shareholder – corporate or individual – the tax rate is determined by reference to their respective highest 2017 tax rate. For corporations, this means the previous standard corporate tax rate of 35%, while individuals previously paid corporate tax at a rate of 39.6%, amounting to a 13% difference in favour of the corporations. Accordingly, the repatriation tax rate paid by the expat running a small restaurant is 13% higher than that paid by Google.
The discriminatory treatment is equally painful on the compliance level. Companies like Google have had years to prepare for the repatriation tax. With armies of in-house tax professionals backed by the biggest accounting and tax law firms, the multinational corporations can plan how to minimise their tax liability. This is not the case for expats.
It was only in February 2018 that expats began to read that they may be subject to this tax. Following a number of articles highlighting the matter, the IRS issued an FAQ document on March 13, explaining the compliance requirements for US shareholders. To make matters worse, the first of eight annual payments of the repatriation tax was originally due on April 15 2018. Failure to make this first payment by the due date meant the entire amount would become due immediately. For illustrative purposes, if an expat had $100,000 in accumulated earnings and profits in cash form, a total tax would be $17,540 ($100,000 x 17.54%). If an election was made under section 965(h)(5), this total liability could be paid over eight years. However, failure to make the first payment by April 15 would immediately result in acceleration of the entire $17,540.
One cannot see the compliance issue in a vacuum. The US tax professionals serving expat small business owners are usually sole practitioners run by accountants and enrolled agents who specialise in preparing simple 1040 forms, Schedule C forms, and in some cases basic Schedule 5471 forms. These tax professionals are wholly unequipped to understand the highly complex provisions of the repatriation tax, let alone help their clients comply.
To this day, expats and their tax professionals are either wholly unaware of the tax, or at best in no position at all to understand its complexities or make the incredibly complex calculations required to actually establish the amounts due.In essence, the repatriation law has created an entire class of non-compliant taxpayers.
To quote one expat who surveyed expats in one country: “I have had feedback from others that have stopped any effort to comply with Repat tax …. The reason for the stopped effort was because of the high cost of compliance and the wasted money… This is particularly the case with longer-term business owners. Even others have stated that they have no intention to comply because the impact would be so devastating.”
Disastrous impact of the GILTI regime
While the impact of GILTI on expats has received less attention, its consequences are far more devastating and discriminatory.
Firstly, starting in 2018, the GILTI tax is annual. Secondly, despite its name, GILTI impacts virtually all businesses, not only those with “intangible” income. Thirdly, the US tax rate for individual US shareholders is 37%. Finally, the law is too complex that the even the most compliant expat will be unable to comply with it.
The GILTI regime creates a multitude of complex terms that are far beyond the abilities of a small expat business owner or its CPA or enrolled agent to understand, let alone comply with. However, let us assume that at the highest level of abstraction GILTI income equals net income after allowing for 10% depreciation on tangible assets. Far more troubling, however, is the discriminatory manner by which the individual US shareholder expat is treated.
Under GILTI, corporate US shareholders like Google will pay GILTI taxes of 21% at most, but no GILTI tax at all if its subsidiaries are located in countries where the corporate tax rates are equal or above 13.125%. The individual US shareholder expat operating a restaurant in any country will pay GILTI taxes of up to 37%.
How is this possible? Firstly, Google is a corporate US shareholder entitled to a deduction of half its GILTI income under Internal Revenue Code 250. Secondly, Google is entitled to a credit of up to 80% of the foreign taxes paid by its subsidiary. The individual expat is not entitled to either of these benefits. Finally, while Google is taxed at the maximum US rate of 21%, the expat’s US tax rate will generally be 37%.
For example, assume that a restaurant run via a CFC has GILTI income (or roughly net income) of $400,000 and pays a 20% foreign corporate tax, or $80,000. Also assume that the CFC has two 50% shareholders, one a US corporate investor (US Inc) and one expat who runs the business. US Inc may reduce its GILTI income by 50% or $100,000. Thus US Inc would have initial GILTI tax liability of $21,000 ($100,000 x 21%), while the expat would have an initial tax of $74,000 ($200,000 x 37%). US Inc is also entitled to a tax credit of $32,000 ($200,000 x 20% x 0.8:2), while the expat would get no tax credit. In summary, US Inc pays a total of 20% in foreign taxes and no GILTI taxes. The expat pays a total of $94,000 in taxes ($20,000 in foreign taxes and $74,000 in GILTI taxes).
This GILTI tax will drive many expats out of business. The only reasonable conclusion that can be reached is that the law was erroneously drafted.
Expats and their US–based contemporaries
A US-based small restaurant owner operating through a US corporation is not subject to either the repatriation or GITLI taxes as the corporation is not a foreign corporation. If the US corporation generates a profit, it pays a one-time corporate tax rate of 21%, and nothing more. One can only imagine the public outcry that would occur in the US if a law was passed that pierced the corporate veil for tax purposes and subjected the shareholder to personal tax on the corporation’s retained earnings.
Expats and their local country X competitors
These new taxes put expats at a significant competitive disadvantage compared to their US counterparts.
For example, a country X restaurant owned by a non-American would have $17,540 more at its disposal than the expat as a result of the repatriation tax, and $74,000 a year more as a result of the annual GILTI tax. At such a significant financial disadvantage, how can the expat survive, let alone invest in the business and compete for customers?
To summarise, despite the stated intention of the TCJA to cut taxes for all Americans, expats have been hammered by the new taxes. Expats running small businesses are significantly discriminated against compared to the huge multinationals, identical US-based businesses, and the expat’s local competitors. The new taxes will have one of two likely results: drive the expat out of business or force the expat to be tax non-compliant.