Is the Transition tax constitutional?
The Supreme Court has agreed to hear a constitutional challenge to the Transition tax. In Moore v. United States, the Court will decide whether the Transition tax violates the Constitution. The stakes are significant. A ruling that the tax is unconstitutional would mean that many other taxes – such as GILTI – all which tax money held in foreign corporations without there being an actual dividend paid to the shareholders – are void. Such ruling would invalidate the efforts of Congress to pass laws which seek to prevent US multinationals (Google, Apple and Microsoft) from shifting profits to low tax countries. Given the impact of the ruling on big business, it is not surprising that many organizations and lobbying entities supported by big business have filed briefs in support of Moore.
The Transition tax was enacted as part of the Tax Cuts and Jobs Act of 2017 (TCJA). The Transition tax imposed a tax on over 2 trillion dollars which were being held if foreign subsidiaries of US multinationals. Without the Transition tax, there was no way for the US to impose tax on these amounts.
Mr, & Mrs. Moore, US citizens, invested a small amount of money and were 11% shareholders in a company in India which dealt with assisting poor farmers. All profits of the India company were reinvested in the business so that the Moores never received any distributions on their investment. As a result of the Transition tax, the Moores were forced to pay Transition tax on the profits of the Indian corporation though they never received any dividends.
The Moores sued, claiming that the tax was unconstitutional. They lost at trial. The federal court of appeals also ruled against them as well, finding that the constitution did not require that Congress only tax money after the taxpayer receive money.
The legal argument
The constitution states that Congress may impose taxes on persons and their property only if the revenue from the tax is apportioned among the states according to population (ie in proportion to the state’s share of the US population). In reality, however, this would make it impossible for Congress to institute any federal income tax. Indeed, until 1909 attempts to pass a federal income tax were held unconstitutional based on the constitutional restriction above. So in 1909 the USA adopted the Sixteenth Amendment, which allows Congress “to lay and collect tax on incomes, from whatever source derived, without apportionment.”
The question in Moore is whether the Transition tax is a tax on income within the meaning of the Sixteenth Amendment or a direct non-income tax that must be apportioned among the states.
The Moores’ position is that the Sixteenth Amendment is limited to taxes on income – meaning gains actually received. The government’s position is that actual receipt of income is not required for a tax to apply. Indeed the government argues that the Moores’ position would invalidate many taxes aimed at preventing tax abuse by large corporations.
The impact of a ruling
A ruling in favor the Moores would have major implications on the legality of taxes imposed under Subpart F of the Internal Revenue Code – which is the main tool that Congress has used to impose tax on profits that multinationals have transferred overseas to avoid US taxation.
To read the briefs filed by the two sides see