April 4, 2018 update: On April 2, 2018, the Internal Revenue Service released Notice 2018-26, which provides further guidance on the repatriation toll charge, discussed in this Tax Insights. The notice, among other things, extends the deadline to pay the first (of eight payments) of the toll charge from April 17, 2018 to June 15, 2018, if you live outside the United States and qualify for the June 15th extended filing deadline for your Form 1040.
The remainder of this Tax Insights was published on March 29, 2018. It has been altered to reflect this update.
If you are a US citizen or resident or have US family members involved in your Canadian business, consider how the recent US tax reform may impact you.
On December 22, 2017, President Donald Trump signed into law the Tax Cuts and Jobs Act (the Act). The changes:
These changes may have a significant impact on US individuals and require that you review the profit distribution strategy of your Canadian business. Although these rules apply to both US corporate and individual shareholders, this Tax Insights focuses on US individual shareholders of a private Canadian company.
The Act introduces a one-time “toll charge” on a non-US corporation’s undistributed, post-1986 foreign earnings and profit (E&P), which is included in US taxable income for the 2017 taxation year. This toll charge can apply to US corporate and individual shareholders.
You are considered a US shareholder if you are a US citizen or resident and own, directly or indirectly, more than 10% of the voting power of a controlled foreign corporation (CFC). A CFC is a non-US corporation if more than 50% of its stock (by vote or value) is owned by US shareholders.
The toll charge uses the mechanics under subpart F of the Internal Revenue Code (IRC) to impose an income inclusion that will be taxed at effective rates of 15% to 17.54% for E&P related to cash and cash equivalents, or 8% to 9.05% for other assets. The mechanics of the toll charge to US individual shareholders operate generally in a similar manner to US corporations; however, the effective tax rate for individuals is at the higher end of the above noted ranges.
To illustrate, this toll charge could apply if you are a Canadian resident and a US citizen and you own 100% of a Canadian private corporation (Canco) and active business profits have accumulated over the past several years to take advantage of low Canadian corporate tax rates. You will be considered a US shareholder and Canco will be a CFC.
If you are subject to the toll charge, you can elect to pay the balance owing over 8 years with:
However, you should act now as the first payment is due by:
Immediate next steps
As previously noted, a CFC is a non US corporation if more than 50% of its stock (by vote or value) is owned by US shareholders. The Act expands the definition of a US shareholder, effective 2018, to include US persons who own more than 10% of the voting power or value of a CFC; the previous definition required that the 10% test considered only voting power and not value. Therefore, US shareholder status could have been avoided by ensuring that the US shareholder owned only non-voting shares. Since this is no longer the case, there will likely be more companies that are considered CFCs.
While the toll charge applies to pre 2018 business profits, the new tax on “global intangible low-taxed income” (GILTI) may apply to your 2018 and future profits. GILTI is computed annually and is the excess of each US individual shareholder’s “net CFC tested income” over the shareholder’s “net deemed tangible income return.”
Net deemed tangible income return is 10% of the tax basis of depreciable assets. This means that a US individual shareholder of a CFC will be subject to US tax on any active business income earned in the Canadian company, reduced by 10% of the tax basis of its depreciable assets. Therefore, if your company has minimal fixed assets, or if they are fully depreciated, all of its business profits may be subject to this new tax.
The tax rate that applies to the GILTI inclusion for individuals can be significantly higher than the tax rate that applies to a US corporation’s GILTI, because the GILTI tax will be at the US individual tax rates with no corresponding deductions or foreign tax credits that are otherwise available to corporations.
The GILTI will be a subpart F income inclusion for individuals and taxed at marginal personal tax rates. The top federal tax rate for US taxpayers is 37%.
Individuals may elect under IRC section 962 to be taxed as a corporation. A number of factors must be considered before making this election.
The implications of the Act on US shareholders of Canadian companies can be significant. Thus, it is important that you act now to avoid any negative consequences.